Understanding the Profit & Loss Statement

Updated: Sep 9, 2018

What information can you get from the Profit and Loss (P&L) statement?

Commonly referred to as the income statement, it is a financial statement that summarizes the revenues, costs and expenses incurred during a specific period of time. These records provide information about a company's ability – or lack thereof – to generate profit. Profit is calculated by subtracting expenses from revenues.

Cash vs. Accrual

Revenues and expenses are recognized at the time money is exchanged under the cash basis of accounting. The accrual method of accounting requires that revenues and expenses be recognized at the time services are rendered whether or not payment has been made. Cash basis is common among sole proprietors and small organizations. Large corporations typically follow the accrual method. A CPA can help you decide whether your business should use the cash or accrual method of accounting for tax purposes. The method chosen will be used for all reporting purposes and should be indicated on the Profit & Loss, Balance Sheet, and Statement of Cash Flows.

Cost of Goods Sold

Some companies keep track of direct costs attributable to the goods produced and sold by a business as Cost of Goods Sold (COGS). This is most common in the manufacturing or merchandising industries. Common expenses classified as COGS include material costs and direct labor. Revenues minus COGS equals gross profit. Operating costs such as office expenses, administrative expenses, advertising, R&D, etc. are considered next on the income statement.

Grouping Your Expenses

The financial statement can be as broad or specific as you choose. This is determined by the number and specificity of your Chart of Accounts. A simplified income statement will give you the bottom line but may leave out details that are important to you. A more detailed income statement translates to a clearer financial picture of each individual function of the small business. Some expenses can be broken down into sub accounts, such as utilities, insurance, and travel: Utilities Expense

  • Telephone

  • Electricity

  • Water/Sewer

Insurance Expense

  • Business Liability

  • Errors & Omissions

Travel Expense

  • Fuel

  • Lodging

  • Ground Transportation

  • Parking

  • Airfare

  • Meals

Net Income and the Balance Sheet