Even if you don't need to take out a loan to fund your small business, you’ll need up-to-date financial statements to guide you, help you make business decisions, and assist you in setting goals.
One of the most important financial statement any business needs is a profit and loss statement (called a "P&L"), also called an income statement.
Why do I need to prepare a Profit and Loss Statement?
Calculating the profit and loss of your business help you make decisions.
Another important reason to prepare a P&L statement is because it is required by the IRS. It’s the record of a business’ operation that is used to assess taxes on profits earned. A P&L is the only financial statement required by the IRS.
P&L statements help you project sales and expenses. Accountants and investors study a P&L statement carefully, scrutinizing cash flow and debt financing capabilities. According to Investopedia, along with the balance sheet and statement of cash flow, an income statement forms the backbone of basic accounting analysis.
Review your profit and loss statement regularly, at least every quarter. For more about small business taxes, review:
What is a 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 a business P&L statement?
Most numbers 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.
- Any petty cash transactions or other cash transactions for which you have receipts.
- A listing of all sources of income - checks, credit card payments, etc. generally found on your bank statement.
- 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.
Details to help calculate a P&L statement
Here are calculations to understand when preparing your P&L statement.
Revenues – expenses = net profit.
P&L statements generally follow this format:
– Operating (variable) expenses
= Gross profit (operating) margin
– Overhead (fixed expenses)
= Operating income
+/– Other income or expense (non-operating)
= Pre-tax income
– Income taxes
= Net income (after taxes)
These categories are defined as:
- Revenue: Money you receive in payment for your products or services.
- Operating, or variable, expenses: Expenses that rise or fall based on your sales volume.
- Gross profit margin or operating margin: The amount left when you subtract operating expenses from revenues.
- Overhead, or fixed, expenses: Costs that don’t vary much month-to-month and don’t rise or fall with the number of sales you make. Examples might include salaries of office staff, rent, or insurance.
- Operating income: Income after deducting operating and overhead expense.
- Other income or expenses (non-operating): Other income might include interest or dividends from company investments. Other expenses might include interest paid on loans.
- Pre-tax income: Income before federal and state governments take their share.
- Income taxes: How income tax is shown on the P&L varies based on the type of legal entity. A C corporation almost always shows income tax expense, but S corporations, partnerships, LLCs, and sole proprietorships rarely show income tax expense on the P&L.
- Net income (after taxes): The final amount on most profit-and-loss statements. It represents the net total profit earned by the business during the period, above and beyond all related costs and expenses.
The SmartBiz Small Business Blog has additional resources you need to run a profitable and successful business. Visit these links for more information: