What is a Profit and Loss Statement & Why it is Critically Important?

Profit and Loss Statement

A profit and loss statement (or P&L) is a useful financial statement that business owners rely upon as a guide. For new business owners, however, many of the financial statements are quite confusing. While the balance sheet is a statement of the assets and liabilities of the business, the P&L is less clear. We’ve already written about retained earnings, so we thought it was high time we tackled the P&L for our readers too. So, let’s get started.

Profit and Loss Statement

What is a Profit and Loss Statement?

Firstly, the profit and loss statement goes by several names. It’s often referred to as the P&L, but it may also be called an income statement (despite including expenses too). So, don’t get tripped up this. Simply put, the P&L statement is a financial report that provides a summarized picture of the revenue and expenses for a specific period. The period would usually be quarterly or yearly, but it can be monthly or bi-yearly depending on what the owner prefers to see.

The idea with P&L statements is that it clarifies for the given period whether the business made a profit or lost money. While this may not reflect the likely outcome for the full financial year, it provides a useful guide.

Should You Create One Right Away?

For new or newer businesses, it’s beneficial to create a P&L right away. The first P&L is likely to be a proforma one. This allows you to project what figures are expected to hit the statement over the first 30 days or more. The proforma P&L is often used to provide lenders with valuable information and to clarify what their expectations should be. Otherwise, knowing what to anticipate of a new business is difficult. Beyond that, a periodic P&L can be produced every month until the business is operating at a profit and won’t likely need a sharp course correction.

How Do They Help You Operate a Business?

The P&L typically includes the following information (where relevant):

Revenue from Sales – Income from the sale of services or goods.

Rent and/or Lease Receipts – Real estate or equipment leasing income.

Licensing and Royalties – Income from licensing the use of an asset or royalties from a product or other asset to another business.

Non-Operating Income – Typically interest from investments or balances on the account.

Capital Gains – Profits from the sale or disposal of assets, i.e., real estate, computers, and other equipment of value. These categorizations ensure that one-time sales are not recognized as sales revenue expected to continue.

There may also be other categories included depending on the type of business being operated. However, the idea remains the same; to provide clarity about what profit or loss in the business is being generated.

A P&L must be created for the business. It provides a reasonable overview on a monthly, quarterly, or yearly basis about how the business is progressing. Trying to operate without one through the financial year may lead to unexpected issues.

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About the Author: Mike