What is a Profit and Loss Statement: Key Component & Examples

Introduction 

At the end of the accounting period, companies release financial statements, including balance sheets, profit and loss statements (income statements), and cash flow statements. These financial reports are crucial for both the business and the stakeholders, as they provide valuable insights into the organization’s financial position and performance.

Each of the financial statements serves a different purpose for the business. Among them, the income statement reflects how profitable the business has been for a specific period of time.

In this blog, we are going to discuss what the profit and loss statement is, its key components, methods for preparing it and how to effectively analyze the income statement.

What is a Profit and Loss Statement? 

A profit and loss (P&L) statement, also known as an income statement, is a type of financial report providing information about a company’s revenues, expenses, and profit/loss over a specific accounting period. It showcases the financial position of a business, reflecting how they are generating revenue, managing expenses, and generating profit.

Net profit or net loss is calculated by subtracting the total expenses from the total revenue that the company generated during a specific period of time.

Net profit/ Net loss = Total revenue – Total expenses

The P&L statement is one of the three crucial financial statements that companies periodically release to the public and stakeholders. Together with the balance sheet and the cash flow statement, the income statement shows how a company has been performing financially and enables both the company and the stakeholders to make better strategic and financial decisions.

Types of Profit and Loss Statement 

There are two ways to prepare the P&L statement based on the accounting method a company utilizes. A company can either use the cash basis accounting method or the accrual basis of accounting to record transactions and prepare financial statements.

1. Cash basis accounting method

   The cash basis accounting method is a much simpler and straightforward method compared to accrual accounting. Under the cash basis accounting, transactions are recorded when actual cash is exchanged for goods and services. The revenues and expenses are also reported accordingly on the income statement when actual cash exchange takes place. This method is generally used by small businesses or individual business owners to manage day-to-day cash flow and provides a simple overview of financial performance.

2. Accrual accounting method

   The accrual basis of accounting is more comprehensive than the cash basis method. According to this method, transactions are recorded when the transaction occurs irrespective of when actual cash is received or paid. Under accounting standards such as GAAP, public companies are mandated to use the accrual accounting method as it presents a more accurate picture of a company’s financial position.
   In this method, on the income statement, the revenue is recorded on the date when the company sends out the invoice for a sale. Similarly, expenses are recorded when the company receives the bill for any goods or services.

Key Components of a Profit and Loss Statement

Each company prepares their income statement in a different format according to their requirements and the complexity of their operations. However, the typical components of the P&L statement are as follows:

1. Revenue: Revenue is the money a company earns or receives specifically from sales of their products or services. This may include gross sales (revenue before any deductions) and net sales (revenue after deductions such as discounts, returns and allowances).
2. Cost of goods sold (COGS): COGS is the direct cost associated with producing a company’s products or services. The cost of goods sold includes costs of labor, raw material costs and manufacturing overhead.
3. Gross profit: Gross profit or gross income is the difference between revenue and COGS. It shows how much the business is earning from its core activities before accounting for operating expenses.
4. Operating expenses: Operating expenses are expenses required to run a business that are not directly associated with production of goods or services. This includes administration expenses, marketing expenses, salaries, rent, utilities, depreciation and amortization costs of tangible and intangible assets, and research and development costs.
5. Operating income: Operating income is the company’s profit obtained after deducting operating expenses from gross profit. It includes revenue earned before taxes, depreciation and amortization costs.
6. Other operating expenses and income:. Non-operating income is the income a company earns outside of its core activities, such as interest income or earnings from investments. Non-operating expenses include expenses such as interest payment on loans or losses related to asset sale.
7. Taxes: Income tax expense is the tax liability of the company on Earning Before Tax (EBT).
8. Net profit: Net profit reflects the final profit earned by the company deducting all expenses both operating and non-operating expenses and taxes. It represents how well the company has performed financially.

Example of Profit and Loss Statement 

Here’s an example of Nestle India’s income statement for the year 2023. As you can see, the company has listed down revenue and profit generated from different sources. The next section includes all the expenses that the company had in 2023, including operating expenses, other expenses, and taxes. At the end of the P&L statement, the net profit of the company for the year 2023 has been calculated based on the income generated and the total expenses.

Source

How to Analyze a Profit and Loss Statement

Once the P&L statement has been prepared, it’s also important to know how to analyze it to get critical financial insights about the business. Proper analysis of the income statement can guide future strategic decision-making for the business as well as its stakeholders. For the business, income statement analysis can help attract investors and improve their financial health.

Here are the key steps to analyze the income statement:

1. Understand the structure: As the first step, it’s crucial to understand the structure of the income statement and all its key components. Another important aspect to notice is the time period covered by the income statement. It could be quarterly, monthly, or yearly, as per a business’ need.
2. Benchmarking: Benchmarking involves comparing how the company is performing financially as compared to their competitors in the same industry. This allows organizations to identify dominant trends in the industry, determine where they are performing well and where they are lacking as compared to their peers and identify areas to work on to improve their operations.
3. Horizontal analysis: In this method, the company’s current period’s income statement is compared with prior periods statements. This will allow companies to see what kind of growth they have been experiencing over the years.This also enables them to identify any key trends related revenue, expenses and profitability.
4. Ratio analysis: It’s crucial for businesses to measure key ratios, such as return on sales, debt to equity ratio, and return on equity. These ratios enable the company to gauge their profitability, analyze how debts are affecting the company’s ability to make profit, and how effectively the company is generating revenue through shareholders’ equity.

How to Create a Profit and Loss Statement? 

There are two major ways to create the income statement – the single-step method and the multiple-step method. Let’s understand in detail what both of these methods entail.

• Single-step method

This method is ideal for small businesses and individual business owners who want to understand their net profit or loss for a given period of time. Under the single-step method, the company doesn’t need to offer a breakdown of different sources or expenses, and the net profit can be calculated by subtracting the total expenses from total revenue.

Net profit = Total revenue (revenue + gains) – Total expenses (expenses + losses)

• Multiple-step method

This method of creating the P&L statement is used by public companies that need to follow accounting standards. Businesses using the multiple-step method need to provide a complete breakdown of their operating revenue and expenses, non-operating revenue and expenses, depreciation and amortization costs, etc.

The multi-step method of creating the P&L statement is much more organized and detailed than the single-step method and therefore requires meticulous attention. Due to this, it is advisable for large companies to leverage a robust accounting system.

Here are the steps to create the P&L statement using the multi-step method:

1. Calculate net sales.

   Net sales = Gross sales – Allowances, Returns, and Discounts

2. Calculate gross profit.

   Gross Profit = Net Sales – COGS

3. Calculate operating profit.

   Operating Profit = Gross profit – operating Expenses

4. Calculate earnings before tax.

   EBT = Operating Profit – Other Expenses

5. Calculate income tax by deducting estimated taxes.
6. Calculate net profit.

   Net Profit = EBT – Taxes

How HighRadius Can Help

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FAQs

1. How to create a profit and loss statement

There are two ways to create a profit and loss statement: the single-step method and the multiple-step method. Under the single-step method, businesses only need to calculate the net profit by subtracting the total expenses from the total revenue. The multi-step process provides a complete breakdown of all the expenses and income sources.

2. Is profit and loss the same as an income statement

Yes, the profit and loss statement is also referred to as the income statement. Apart from this,the statement of operations is another way to refer to the profit and loss statement. These statements provide crucial information regarding the financial position of a company for a specific time period.

3. How do I read a profit and loss statement

In order to read the profit and loss statement, you need to familiarize yourself with all the key components included in the statement, including operating expenses and income, cost of goods sold, non-operating expenses and income, and depreciation and amortization costs.

4. How often are profit and loss statements prepared

The number of times a company prepares its profit and loss statement depends on their operations, needs, and internal functioning. A company can prepare the profit and loss statement on a monthly, quarterly, or annual basis.