Preparing Financial Statements – The Statement of Profit and Loss
The statement of profit and loss is by far the favorite among business owners; after all, this is the one that shows the profits. This statement can show you much more than the bottom line, though. It can let you know if you’ve been setting your prices too low, paying too much for the merchandise that you resell, or spending much too much on postage. In addition to spelling out just how well your business has done over the past year (or month or quarter), it contains clues for improving profitability and beefing up that bottom line.
FACT
Statements of profit and loss for service businesses are shorter than those for product-based businesses. Service companies don’t need a section for cost of goods sold or gross profit, because they don’t sell any goods. Other than that missing section, the statements look pretty much the same.
First, though, you have to put it together. Three kinds of accounts appear on this financial statement: revenues, costs, and expenses. The statement is a kind of vertical equation that basically says “revenues minus costs minus expenses equals profit or loss.” In the body of the report, revenues are listed right on top; costs (if you sell products) come next; and expenses are at the end. At the very bottom comes the bottom line, the company’s overall net profit or loss for the period.
All statements of profit and loss are topped with a standard report heading, which contains three lines:
- The name of the company (ABC Company)
- The name of the statement (Statement of Profit and Loss)
- The period covered by the statement (For the year ended December 31, 2007)
You have some leeway with the name of the statement, as long as readers can tell what kind of report it is. Other common names for this financial report include “income statement,” “profit and loss statement,” and “report of earnings”; when your accountant is talking about the report, she’ll probably call it your “p & l.” The period line must reflect the actual time covered by the statement, whether it’s a month, a quarter, or a year.
Getting to the Bottom Line
The statement of profit and loss is put together using compiled data from actual business transactions. It details how your company earned money, along with how much was spent in trying to create revenues. You can pull final numbers from your general ledger or from a completed working trial balance.
Once you have all the raw numbers you need, you can begin to put them together and start your calculations. Revenues always come first. Start with your gross revenues, which just means your total sales; if you have more than one sales account, you can list them individually and then total them, or just include the combined total figure. Then you subtract any contra sales accounts, such as sales discounts or sales returns. The result of that calculation is called your net sales. If you don’t have any contra sales accounts, your gross sales and net sales will be the same, and you don’t need to list both.
ALERT!
When your company uses the cash accounting method, include only sales for which the cash has already been received. If no cash has changed hands yet, don’t include the sale. For accrual accounting, you have to include every sale transaction, regardless of whether your company has gotten any money.
For product-based businesses, the cost of goods sold section comes next. On your statement of profit and loss, you can either show the net cost of goods number or display the whole calculation. When you’re doing the report for yourself, it’s easier to have the calculation right there on the same page; when you’re preparing the report for someone else, you may include just that final number in the financial statement along with a more detailed supporting schedule (just attach that to the back). The full-blown computation starts with your beginning inventory, then adds in all the purchases of the period to give you the total cost of goods available for sale. From that subtotal, subtract the ending inventory (what you have left in stock) to get the cost of goods sold. Next, subtract your cost of goods sold from your net sales to come up with your gross profit.
The next section of the statement is common for all businesses, and it includes all the company’s expenses for the period. You can choose to group the expenses—into variable and fixed, or sales and general, for example—or you can just list them all in one big group. The most com- mon division is between selling expenses and general and administrative expenses. If you don’t have a lot of different expense accounts, though, it’s easier for you to just keep them all together. (To refresh your memory about which expenses belong in which category, check out Chapter 8.) Regardless of how or whether you divide up your expenses on the report, you still need to come to a grand total for all the operating expenses.
Finally, you’ve reached the bottom line. To get to your company’s profit or loss for the period, subtract the total operating expenses from the gross profit (for product-based businesses) or from the net sales (for service businesses). When the result is positive, your company has made a profit; when the result is negative, it has sustained a loss for the period.
What This Statement Really Looks Like
Now that you know what goes into a statement of profit and loss, here’s one you can use as a guideline for creating your own. This example includes virtually everything, which means that some lines may not apply to your company. Remember, service businesses won’t have the cost of goods sold section, so you can skip that part if your company doesn’t sell any products.
If your business is a C corporation, you may include an extra section for income taxes, since C corporations do have to pay taxes on their own income. In that case, you’ll rename that net profit line “net profit before income taxes.” Then, add in a line for the amount of income taxes that will be due; remember to include federal, state, and local levies. Finally, subtract your tax figure from that preliminary profit to get your final bottom line, typically called “net profit after taxes.”
XYZ Company
Statement of Profit and Loss for the Period Ended December 31, 2006
Revenues
Sales Revenues: $130,000
Less: Sales Discounts: 2,000
Net Sales Revenues: $128,000
Cost of Goods Sold
Beginning Inventory: $ 30,000
Plus: Purchases: 80,000
Cost of Goods Available for Sale: 110,000
Less: Ending Inventory: 50,000
Cost of Goods Sold: $60,000
Gross Profit: $68,000
Expenses
Selling Expenses
Advertising: $3,000
Delivery Charges: 1,500
Packing Costs: 2,500
Sales Salaries & Commissions: 22,000
Total Selling Expenses: $29,000
Administrative Expenses
Computer Expenses: $300
Depreciation: 500
Insurance: 800
Office Expense: 250
Office Salaries: 18,000
Rent: 6,000
Utilities: 450
Miscellaneous: 100
Total Administrative Expenses: $26,400
Total Expenses: $55,400
Net Profit $12,600