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Profit Loss Statements have become like the Lebron James of financial statements. As soon as it came into the financial league, it has been crowned King.
But the thing is, it may be well deserved.
The P&L statement is vital not just for obtaining financing for lenders but is an essential report that helps decision-makers make correct short term and long term decisions.
It does this in the following ways….
Periodic P&L. Every business needs to prepare and review its profit and loss statement periodically – at least every quarter. Reviewing the profit and loss statement helps the business make decisions and to prepare the business tax return. Your business tax return will use the information from the P&L as the basis for the calculation of net income, to determine the income tax your business must pay.
Pro Forma P&L. A new business needs to create a profit and loss statement at startup. This statement is created pro forma, meaning that it is projected into the future. Your business will also need a pro forma P&L when applying for funding for any new business project.
What information do I need to prepare this statement?
Most of the information for this statement comes from your first-year monthly budget (cash flow statement), and from estimated calculations on depreciation from your tax advisor. Specifically, you will need:
- A transaction listing, of all the transactions in your business checking account and all the purchases made with your business credit cards.
- Include any petty cash transactions or other cash transactions for which you have receipts.
- For income, you will need a listing of all sources of income – checks, credit card payments, etc. You should be able to find these on your bank statement.
- You will also need information on any reductions to sale, like discounts or returns.
If you are using business accounting software, the profit and loss statement should be included with the standard reports. Even if you have this report in your system, you should still know what information is required to prepare the report.
Adding Cash Transactions to Your P&L
Don’t forget to add cash transactions, both income and expenses. Even if you have business accounting software, you may still have to enter cash transactions manually, including cash for petty cash and income. If you accept cash from customers, use a cash transaction form (available from office supply companies) or a simple invoice.
For cash payments, save the receipt. These receipts are especially important for business driving and business meals expenses.
Preparing a Pro Forma (Projected Profit and Loss Statement
If you are starting a business, you don’t yet have the information to prepare a real P&L statement, so you have to guess. A pro forma statement is usually prepared for each month of the first year in business, but your lender may require you to add more months or years to the projection to show the break-even point when your business is generating positive cash flow on a consistent basis.
1. List all possible expenses, over-estimating so you aren’t surprised. Don’t forget to add a category for “miscellaneous” and an amount.
2. Estimate sales for each month. Under-estimate sales, both in timing and amount.
3. The difference between expenses and sales is usually negative for some period of time. The negative amounts should be accumulated to give you an idea of how much you will need to borrow to get your business started.
|Sample Company Profit and Loss Statement / For the Year Ending 12/31/2019|
|INCOME||% of Total Income|
|Total Expenses||$ 24,759||54%|
|NET INCOME||$ 20,741||46%|
- List different types of income separately, so you can see each as a percentage of total income.
- Including percentages helps you analyze your P&L over time
- List expenses alphabetically, in the same order as your business tax return, to make it easy to transfer information to your return.
Preparing a Periodic Profit and Loss Statement
The preparation process and information needed is the same whether you are preparing a statement at startup or to use for tax preparation or business analysis. For each row, you will have a quarterly amount and then a total for the year.
- First, show your business net income (usually titled “Sales”) for each quarter of the year. You can break down the income into sub-sections to show income from different sources if you wish.
- Then, itemize your business expenses for each quarter. Show each expense as a percentage of Sales. All expenses should total to 100% of Sales.
- Then show the difference between Sales and Expenses as Earnings. This is sometimes called EBITDA (earnings before interest, taxes, depreciation, amortization).
- Then show total interest on your business debt for the year and subtract from EBITDA.
- Next list taxes on net income (usually estimated) and subtract.
- Finally, show total depreciation and amortization for the year and subtract.
The number you have now is net earnings, or your business profit – or loss.
One way to present operating expenses in a profit center’s P&L report is to list them according to the object of expenditure basis. This means that expenses are classified according to what is purchased (the object of the expenditure) — such as salaries and wages, commissions paid to salespersons, rent, depreciation, shipping costs, real estate taxes, advertising, insurance, utilities, office supplies, telephone costs, and so on.
To do this, the operating expenses of the business have to be recorded in such a way that these costs can be traced to each of its various profit centers. For example, employee salaries of persons working in a particular profit center are recorded as belonging to that profit center.
The object of expenditure basis for reporting operating costs to managers of profit centers is practical and convenient. And this information is useful for management control because, generally speaking, controlling costs focuses on the particular items being bought by the business.
Reporting operating expenses on their cost behavior basis
Margin is the residual amount after all variable expenses of making sales are deducted from sales revenue. The first and largest variable expense of making sales is the cost of goods sold expense (for companies that sell products). But most businesses also have other variable expenses that depend either on the volume of sales (quantities sold) or the dollar amount of sales (sales revenue).
In addition to variable operating expenses of making sales, most businesses have fixed expenses that are not sensitive to sales activity in the short run. Margin equals profit after all variable costs are deducted from sales revenue but before fixed costs are deducted from sales revenue.
The following figure presents a P&L report for a profit center example that classifies operating expenses according to how they behave relative to sales activity. The detailed expenses under each major heading are not presented in the P&L report itself; instead, this information is presented in supporting schedules that supplement the main page of the P&L report.
This two-level approach provides a hierarchy of information. The most important and critical information is included in the main P&L report, in summary form. As time permits, the manager can drill down to the more detailed information in the supporting schedules for each variable and fixed expense in the main P&L report.
The supplementary information for each variable and fixed expense is presented according to the object of expenditure basis. For example, depreciation on the profit center’s fixed assets is one of several items listed in the direct fixed expenses category. The amount of commissions paid to salespersons is listed in the revenue-driven expenses category.
The example shown in the figure is an annual P&L report. Profit reports are prepared as frequently as needed by managers, monthly in most cases. Interim P&L reports may be abbreviated versions of the annual report. But at least once a year, and preferably more often, the manager should see the complete picture of all expenses of the profit center. Keep in mind that this example is for just one slice of the total business, which has other profit centers each with its own profit (P&L) report.
The P&L report shown in the figure includes sales volume, which is the total number of units of product sold during the period. Of course, the accounting system of a business has to be designed to accumulate sales volume information for the P&L report of each profit center.
Stopping at operating earnings
In the figure, the P&L report terminates at the operating earnings line; it does not include interest expense or income tax expense. Interest expense and income tax expense are business-wide types of expenses, which are the responsibility of the financial executive(s) of the business.
Generally, interest and income tax expenses are not assigned to profit centers, unless a profit center is a rather large and autonomous organizational division of the business that has responsibility for its own assets, finances, and income tax.
The measure of profit before interest and income tax is commonly called operating earnings or operating profit. It also goes by the name earnings before interest and tax, or EBIT. It is not called net income, because this term is reserved for the final bottom-line profit number of a business, after all expenses (including interest and income tax) are deducted from sales revenue.