This article is part of a series of articles that will explain the key components of the financial and operational planning process for small businesses. This is the third article in the series and will explain the next element of the financial plan: the profit and loss statement.
Profit and loss statement
A profit and loss statement shows your businesses revenue and expense activity over a designated period of time. It’s a table that lists your revenue streams and your expenses and shows at the very bottom the total amount of net profit or loss.
This is a financial statement that may be referred to by a few different names—profit and loss statement, income statement, P&L (short for “profit and loss”)—but no matter what you call it, it’s a critical report and very important to understand.
The format for profit and loss statements depend on the type of business you’re in and the structure of your business (nonprofit, LLC, C-Corp, etc.). Generally, the profit and loss statement should include:
- Revenue (also called sales)
- Cost of goods sold (COGS) or Cost of services sold—keep in mind, some types of companies, such as a services firm (accountant or lawyer), provide a service instead of selling “goods”.
- Gross margin, which is revenue less COGS
These three components (revenue, COGS, and gross margin) are the key components of your business model—i.e., how you make money.
You’ll also list your operating expenses, which are the costs associated with running your business that aren’t directly related to making a sale. They’re your fixed expenses that don’t change based on the level of your revenue in a given month—like rent, utilities, and insurance.
The gross margin minus operating expenses will give you your operating income:
Gross Margin – Operating Expenses = Operating Income
Depending on how you classify some of your expenses, your operating income will be equal to your “earnings before interest, taxes, depreciation, and amortization” (EBITDA)—basically, how much you made in profit before considering your accounting and tax obligations. This is also referred to as your “profit before interest and taxes,” gross profit, and “contribution to overhead”—no matter the name, they all refer to the same number.
Your “bottom line”—technially, your net income, which is shown at the very end (or, bottom line) of your profit and loss statement—is your EBITDA less the “ITDA.” When you subtract the interest, taxes, depreciation, and amortization expenses from your EBITDA, the result is your net income:
Operating Income – Interest, Taxes, Depreciation, and Amortization Expenses = Net Income
If you’d like help creating your comprehensive financial plan and understanding the related financial statements … we can help. We specialize in helping businesses create comprehensive financial plans, monitor their financial activity and understand their financial statements. So, if you don’t have the expertise or resources, click here to contact us!