Profit and Loss statements are an important financial tool for your business. Unlike a balance sheet, they summarize your commercial activity across a period of time, rather than at a certain time. Understanding the items on your Profit and Loss statement is crucial because it gives you the full picture on your company's cash flows.

1. Understanding Your Profit and Loss Statement
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So, What is a Profit and Loss Statement?
The Profit and Loss Statement (P&L), also known as the Income Statement, is an important
financial tool. It summarizes your company’s revenues (net sales) minus costs and expenses (i.e.,
Cost of Goods) incurred during a specific operating period. The statement is usually done quarterly
or annually.
In other words, a P&L is a measurement of activity (revenue – expenses=profit)through time
(whatever that operating period is).
A P&L is similar to a Balance Sheet, which is an important measure of Assets & Liabilities. But, the
Balance Sheet is a measure of activity at a certain time.
Why You Need to Understand a Profit and Loss Statement
A profit and loss statement shows how well your business buys and sells inventory or services to
make a profit. As you know, a company needs to create a profit in order to survive and grow.
If you analyze a profit and loss statement, you can determine your business’s cash flow that is
available to repay existing debt, finance additional debt like loans in order to expand your business,
or to reinvest in the business.
Mark Staniszewski, IndustriusCFO’s account manager says, “A business needs to keep good
records of their financial happenings. It’s important for business owners to understand their
expense structure and monitor these expenses to ensure they’re achieving a healthy Gross Margin
and Net Income as measures of profitability. The old adage is ‘you could only improve what you
can measure’ and compiling your P&L is the first step in measuring your company’s revenue minus
expenses.”
In order to show you the positive impact a profit and loss statement provides, we’ve created a
hypothetical example:
Once you understand where your business’s
expenses are in relation to its revenue (typically
done by having all expenses reflect a percent of
total revenue (or Net Sales)) you could observe
that perhaps your business’s Cost of Goods Sold
(COGS) is 40% of Net Sales (NS).
Say your Gross Margin is 60% of NS. If you
compare this to your industry peers, you may see
that your COGS are more than your industry
peers. Your peers are at 35%, with most disparity
in Overhead.

2. So, you can conclude that you are paying more than your peers for Overhead. Then, you could
begin looking at reducing these Overhead expenses, which will save money and increase your
business’s profit.
How to Create a Profit and Loss Statement
You can do this with our eight simple steps!
1. First, list all of your Revenues minus any discounts in order tally up your Net Sales (NS) for a
certain operating period like a fiscal year, for instance. This is the top line from which all expenses
are deducted.
2. Second, if you are a manufacturing company, calculate your COGS. But, if you are a service
company, calculate Cost of Sales. This includes Materials, Labor and Overhead directly involved
with the manufacturing process. A service company will have Labor and Overhead, but probably
not Materials.
3. Then, calculate Gross Profit, which is NS – COGS.
4. Next, deduct from Gross Profit even further by deducting Operating Expenses, such as Rent,
Bad Debt (uncollected/uncollectable debt), Advertising/Marketing expenses, Salaries/Wages
associated with employees not directly related to the production of the product (like managers,
accountants, etc.), and Other Operating Expenses (computers, postage, etc.).
5. After Operating Expenses are deducted, you’re
left with Earnings Before Interest, Taxes,
Depreciation and Amortization (EBITDA). EBITDA
is deducted from by Depreciation (reduction in
value of tangible assets like machines) and if
applicable, Amortization (reduction in value of
intangible assets like patents), leaving Earnings
Before Interest and Taxes (EBIT), otherwise
known as Operating Profit.
6. EBIT (Operating Profit) is deducted from further
by Interest Expenses (from all interest-bearing
debt/loans/liabilities) and any Other Expenses, leaving you with Earnings Before Taxes (EBT).
7. Next, EBT is deducted from by Income Taxes, leaving Net Income.
8. Finally, Net Income is what a business is left with after all expenses!
We know you are passionate about your business and that you may not feel comfortable
interpreting your monthly financial reports. But, we hope that these basic steps help you to
understand how to create a Profit and Loss Statement.