Create Your Profit and Loss Statement in 4 Simple Steps

Whether you’re working as a freelance consultant or managing your own plumbing company, you should know how to create a profit and loss (P&L) statement. Many small business owners and freelancers are hesitant to invest their energy into learning about such topics. After all, you became your own boss so that you can do work you’re passionate about, right? Business finance likely isn’t your main passion in life. However, a basic knowledge of accounting can make or break your business. Read more about why a Profit and Loss Statement is good for the self employed

What is a Profit and Loss (P&L) Statement?

An P&L statement is one of the most important business financial statements. You can use this statement to track revenues and expenses so that you can determine the operating performance of your business over a period of time. Small business owners use these statements to find out which areas of their business are over or under budget.

Pinpointing Essential Items

These statements allow you to pinpoint specific items that are causing unexpected expenditures, such as cell phone use, advertising, or supply expenses. P&L statements can also track dramatic increases in product returns or cost of goods sold as a percentage of sales, and can be used to determine income tax liability.

Lenders and Investors Require Them

P&L statements, along with balance sheets, are the most basic elements required by potential lenders, such as banks, investors, and vendors. They will use the financial reporting contained therein to determine credit limits. Your P&L statement could decide if you get a loan or not. Lenders and investors will also want to see future projected financial statements called pro forma income statements, pro forma balance sheets and pro forma cash flows.

4 Steps for Creating a Profit and Loss Statement

The thought of financial paperwork might make you cringe, especially if you’re not a big fan of math. Don’t stress because creating a P&L statement is pretty easy. There are a few quick steps you need to follow. There is even accounting software like QuickBooks to help.

Here are the four main steps:

• Establish your revenue figures.
• Calculate your operating profit/loss.
• Factor in additional revenue to determine your EBITDA.
• Subtract EBITDA from interest, taxes, depreciation, and amortization.

Step 1: Establish Your Revenue Figures

Revenue encompasses any income your business generates. It includes the total sales that your business makes, whether of products or services. It also includes money that your business received from other avenues, such as selling equipment or through a tax refund. Create a list of these income streams and amounts and tally them up.

What if You Have no Revenue Yet?

If you have just started your business, you may not have revenue yet. In this case, create an estimate. How much money do you expect to make in your first accounting period? You may already have some orders lined up. Forecasting your expected profits and losses will provide a benchmark to measure future business successes and failures.

Establishing Revenue Figures

Establish your revenue figures in the given time frame for which you’re calculating a P&L statement. So, if you’re calculating a P&L statement for Q1, you have to input all your revenue from January, February, and March.

Step 2: Calculate Your Operating Profit/Loss

With your revenue defined, you can calculate your operating profit/loss. There is a precise formula to do this:

(Revenue – Cost of Goods Sold) – Operating Expenses = Operating Profit/Loss

Does that look like gibberish to you? Read on as we define each of those terms and break down the formula for you.

Revenue

We covered it in the section above, but here’s a quick reminder: Your revenue refers to all the income your business has generated in a specified time frame. This includes the sale of goods and services and other income streams, like selling old business equipment.

Cost of Goods Sold (COGS)

The cost of goods sold (COGS) refers to materials costs related to the production or sale of your business product or service. It could cover materials costs, for example, or manpower costs related to manufacturing.

For instance, if you run a coffee shop and sell a to-go coffee for $3.50, you aren’t making a full $3.50 off that sale. You have to subtract costs like the cost of coffee beans and the to-go cup. Another example: If you sell a product that you don’t manufacture yourself, you have to factor in the supplier costs.

Sometimes referred to as “direct costs,” COGS only cover expenses related to the sale or production of your given product or service. They don’t cover indirect costs, like accounting, rent, and marketing. Find out more about the difference between direct and indirect costs.

Gross Profit

To get your gross profit, subtract your COGS (direct costs) from your revenue:

(Revenue – COGS) = Gross Profit

Operating Expenses

Finally, you have to calculate your operating expenses. These are funds required to keep your business running on a day-to-day basis. Operating expenses include:

• Sales salaries: These are the salaries plus bonuses and commissions paid to your sales staff.
• Collateral and promotions: Collateral fees are expenses incurred in the creation or purchase of printed sales materials used by your sales staff in marketing and selling your product. Promotion fees include any product samples and giveaways used to promote or sell your product.
• Advertising: These represent all costs involved in creating and placing print or multimedia advertising.
• Other sales costs: These include any other costs associated with selling your product. They may include travel, client meals, sales meetings, equipment rental for presentations, copying, or miscellaneous printing costs.
• Office salaries: These are the salaries of full- and part-time office personnel.
• Rent: This is the fee incurred to rent or lease office or industrial space.
• Utilities: These include costs for heating, air conditioning, electricity, Internet, and phone usage incurred in connection with your business.
• Depreciation: Depreciation is an annual expense that takes into account the loss in value of equipment used in your business. Some examples of equipment that may be subject to depreciation include computers, office furniture, automobiles, and buildings that you own. If you don’t understand depreciation, don’t worry; I will explain it more carefully in a separate section.
• Other overhead costs: Expense items that do not fall into any of the above categories or cannot be clearly associated with a particular product or function are considered to be other overhead costs. These types of expenses may include insurance, office supplies, or cleaning services.

To complete the formula and get your operating profit/loss, you subtract your total operating expenses from your gross profit. Here’s the formula:

(Revenue – COGS) – Operating Expenses = Operating Profit/Loss

Step 3: Factor in Additional Revenue to Determine Your EBITDA

EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.” This is another measure of profitability. Depreciation refers to any reduction in the value of your business’s assets, such as equipment or machinery. Amortization refers to an accounting technique that may be used to decrease the book value of an intangible asset or loan over a defined period.

A rough calculation of EBITDA would involve subtracting your operating expenses, cost of goods, and depreciation from your total revenue. However, precisely calculating and factoring in depreciation and amortization requires advanced accounting experience, so at this point, it’s best to turn to a professional.

Step 4: Subtract EBITDA from interest, taxes, depreciation, and amortization

Finally, to calculate your operating profit/loss, you must subtract the EBITDA from interest, taxes, depreciation, and amortization. Here’s the formula:

Net Profit/Loss = EBITDA – (Interest + Taxes + Depreciation)

Again, at this point, you’re likely best off leaving the job in the hands of an accountant or bookkeeper. Miscalculating some of these points, like depreciation, can have implications for income taxes. The Internal Revenue Service (IRS) has guidelines governing depreciation of business vehicles, for example, which a skilled tax professional will be well-acquainted with.

Sample Business Profit and Loss Statement Template

Going through an example profit and loss financial report can help clarify the process. Here, we take you through a scenario. Say you work as a freelance graphic designer. You’ve just finished your first quarter of business and want to create a profit and loss report. You follow the steps above.

First, you need to establish your revenue. You sold $18,750 worth of graphic design services in your first three months as a freelancer. You also sold an old computer that you no longer used for work, bringing in another $250. In total, your revenue for the quarter was $19,000.

Here’s how your P&L balance sheet looks so far:

Sales, Services: $18,750

Sales, Other: $250

Total Sales $19,000

Operating Profit/Loss

Next, you want to calculate your operating profit/loss. You calculate your COGS (design software, printing production costs, paper costs, etc.) and see they added up to $2,000. You subtract that from your revenue to get a total of $17,000. That’s your gross profit. Next, you calculate your operating expenses. So far, your P&L statement looks like this:

Sales, Services: $18,750

Sales, Other: $250

Total Sales $19,000

Cost of Goods Sold: $2,000

Gross Profit: $17,000

Operating Expenses

Next comes operating expenses. You paid $3,000 for rent on your office space and $300 for utilities. You don’t have any employees yet, so you don’t have payroll expenses. Since your business is new, you don’t have depreciation and amortization costs to account for yet. Here’s what you’ve got now:

Sales, Services: $18,750

Sales, Other: $250

Total Sales $19,000

Cost of Goods Sold: $2,000

Gross Profit: $17,000

Operating Expenses

Payroll: $0

Rent: $3,000

Utilities: $300

Depreciation and Amortization: $0

Total Operating Expenses: $3,300

Calculating EBITDA

Now, a rough calculation of EBITDA would involve subtracting your operating expenses, cost of goods, and depreciation from your total revenue. So, that’s $19,000 (total sales = total revenue) minus $2,000 minus $3,300, equaling $13,700.

Sales, Services: $18,750

Sales, Other: $250

Total Sales $19,000

Cost of Goods Sold: $2,000

Gross Profit: $17,000

Operating Expenses

Payroll: $0

Rent: $3,000

Utilities: $300

Depreciation and Amortization: $0

Total Operating Expenses: $3,300

EBIT/Operating Profit $13,700

Interest, Taxes, and Depreciation

A bookkeeping professional can then factor in interest, taxes, and depreciation to complete your profit and loss statement using the formula: Net Profit/Loss = EBITDA – (Interest + Taxes + Depreciation). The final statement with all line items accounted for might look something like this:

Sales, Services:                                                    $18,750

Sales, Other:                                                                $250

Total Sales                                                              $19,000

Cost of Goods Sold:                                             $2,000

Gross Profit:                                                         $17,000

Operating Expenses

Payroll:                                                                                  $0

Rent:                                                                             $3,000

Utilities:                                                                          $300

Depreciation and Amortization:                            $0

Total Operating Expenses:                              $3,300

EBIT / Operating Profit:   $13,700

Interest Expense:                                                      $700

EBT / Earnings Before Taxes:                      $13,000

Taxes (assuming a 15% tax rate):                 $1,950

Net Income:                                                          $11,050 

What You Can Learn from a Profit and Loss Statement

So, what’s the point of all those numbers? Your P&L financial statement contains a lot of valuable data. Here are three things you can learn from a P&L statement:

• The financial health of a business
• Business trends over time
• Operational changes or improvements needed

Financial Health of a Business

Simply put, the P&L lets everyone know what the “bottom line” is. A positive profit statement means you are making money. However, if your gross profit is low or negative, it’s time to reassess your business model. Do you need to increase sales? Cut back on operating costs? Identifying the problems allows you to fix them.

Your business’s financial health may also be of interest to external parties. For example, if you approach lenders to take out a loan for your business or take out a business credit card, such documentation can secure a favorable loan or interest rate. Demonstrating strong profit margins is also critical if you ever hope to sell your business.

Business Trends Over Time

To truly excel, business owners need to look for trends in their business over time. A P&L statement helps identify important fluctuations that can inform smart business decisions. Say you run a holiday catering business, for example. Comparing your quarterly P&L statements, you see that Q4 is your strongest-performing quarter. That makes sense since Christmas, Thanksgiving, and New Year’s all fall in this period.

However, you’re surprised to see that Q2 also performs strongly. Reviewing your records, you realize you cater to a lot of graduation parties in May and June. With this knowledge, you expand your Q2 marketing to capture more of this business.

Operational Changes or Improvements Needed

A significant portion of the P&L statement is dedicated to operational details. This can help you identify areas you’re spending too much on, such as rent or payroll. Alternatively, you may find that you can afford to invest more in operating expenses (in the interests of expansion). For example, if you started your small business from home but want to expand with your own office space, you can use your P&L statement to determine if this is feasible.

What to Do Once You Have Your First Profit and Loss Statement

Now, you know the basics of how to create a profit and loss statement. With the information you gain from your P&L statements, you can make important immediate business decisions, like whether you can afford to move to a larger office space or hire new employees. You can also make more “big picture” decisions, from planning your taxes to revamping your growth strategy.

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