Qualities of an Effective Profit & Loss Report

A Profit and Loss (P&L) Report, also called a Profit and Loss Statement, is a key financial document that details a company’s income and expenses over a specific period of time. This time period is typically a month, a quarter or a year. Depending on company needs and circumstances, the report may show results for multiple periods for purposes of comparison and showing trends.

In essence, the P&L report illustrates this formula: Revenue – Cost of Goods Sold = Gross Profit – Expenses = Net Profit or Loss.

Here is an example of a typical profit and loss report:

What Is Included in a Profit and Loss Report?

The main components found in a P&L report are:

• Business name
• Accounting period
• Total Income (Revenue or Sales)
• Cost of Goods Sold (Directly associated expenses to generate the revenue)
• Gross Profit
• Total Expenses
• Net Profit

These items generally appear in the order shown above. In most cases the income and expenses are broken down into categories.

Here are some simple formulas for calculating the figures in the report:

• Gross Profit = Net Sales − Cost of Sales
• Net Operating Profit = Gross Profit − Operating Expenses
• Net Profit before Taxes = Net Operating Profit + Other Income − Other Expenses
• Net Profit (or Loss) = Net Profit before Taxes − Income Tax
• EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) = Net Profit (or Loss) + Interest, Taxes, Depreciation, and Amortization.

How to Create a Profit and Loss Report

For startups and small companies, the P&L report is usually an Excel spreadsheet. As the business grows, it may require the use of more sophisticated accounting software to generate the report.

The report will vary in complexity according to the size and financial circumstances of the company. The basic steps involved in creating a Profit and Loss report are as follows:

1. Calculate net sales by subtracting returns, discounts, allowances, etc. from the gross sales figure.
2. Calculate cost of goods sold by adding together the costs of materials, direct labor, and any production-related overhead expenses.
3. Calculate gross profit by subtracting the cost of goods sold from the net sales figure.
4. Add together all remaining expenses, including wages, to calculate total operating expenses. Subtract this figure from the gross profit to determine operating profit or loss.
5. Calculate the profit or loss before taxes by adding interest income and any non-sales income to the operating profit, to determine profit or loss before taxes.
6. Subtract tax expenses from the before-tax profit to determine net profit or loss. This figure is your company’s bottom line for the period.

Some companies include additional calculations such as EBIT (Earnings Before Interest and Taxes) or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for accounting and fundraising purposes. Large companies may break the report down by division or department. Public companies may include information related to shareholding.

What Is the Purpose of the Profit and Loss Report?

A P&L report is an important tool for determining whether a business is profitable and whether its profitability is trending up or down. By examining the document, company executives can often identify areas where budgets and resources could be adjusted to improve the firm’s bottom line.

The profit & loss report is one of the main financial statements required by generally accepted accounting principles (GAAP). Companies that are publicly traded are required to prepare P&L reports and submit them to the Securities and Exchange Commission (SEC). P&L reports are also valuable for calculating income taxes and for attracting potential investors.

Other Uses of a Profit and Loss Report

The information on the P&L report can be used to calculate various financial ratios that measure the profitability and sustainability of a company. Some of these ratios include:

Gross Margin

Gross margin indicates the relationship between sales and cost of goods sold. A high gross margin indicates that products are selling for much more than they cost to produce or obtain.  A low gross margin may indicate that prices need to be raised or that costs need to be reduced.

There are two ways to calculate gross margin, either of which should yield the same result:

Gross Margin = Gross Profit ÷ Net Sales

or

Gross Margin = (Net Sales – Cost of Goods Sold) ÷ Net Sales

In the example profit & loss report above, gross profit is $355,899 and net sales is $431,245. Therefore, the gross profit is 82.5%. While it appears that the company may be doing well in setting prices and managing production costs, this figure can be misleading because it does not take into account operating expenses and taxes.

Profit Margin

This figure indicates the percentage of profit a company makes from sales after all expenses and taxes are taken into consideration. The formula to calculate this percentage is:

Profit Margin = Net Profit ÷ Net Sales

In the P&L example above, the net profit is $113,101 and net sales is $431,205. This makes the profit margin 26.2% when all expenses are considered. This may or may not be a good figure, depending on how it compares to the industry average. To increase profit margin, the company may need to consult its financial advisor and look for ways to reduce its operating expenses, debts, or tax liability.

Earnings per Share

This figure is important to company shareholders because it indicates the net profit per share of common stock. The formula for computing earnings per share is:

Earnings per Share = Net Profit ÷ Number of Common Shares

In the P&L example above, suppose the average number of common shares outstanding for the period is 224,000. The net profit is $113,101. Therefore, the earnings per share would be 50 cents, which should be evaluated against company projections and shareholder expectations. Stockholders tend to follow this number closely to monitor the value of their investments.

Summary

The profit and loss report is a key financial document that helps a company evaluate its fiscal health and monitor trends over time. It can indicate areas where costs may need to be reduced or prices increased. This report is required for many companies. Many important calculations can be made from the P&L report to help the company maximize profits.

For more information, we invite you to browse the articles at PreferredCFO.com or contact one of our CFOs.

About the Author

David Guyaux

David Guyaux brings over 25 years of experience as CFO, VP of Finance, and Controller roles within both public and private enterprises. He has organized finances for companies to turn around operations and meet compliance and governmental requirements, as well as to prepare for mergers and acquisitions.

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