Profit and Loss (P&L) Statement Defined

No financial metric is an island. A business may have achieved record-breaking sales last quarter — an amazing accomplishment — but if its expenses also reached an all-time high, then the company may be no more profitable than it was the quarter before. To gain a holistic view of business performance, internal management, and external parties, such as investors and lenders, turn to the business’s profit and loss (P&L) statement. One of three main financial statements — along with the balance sheet and the cash flow statement — the P&L includes a business’s revenue, expenses, and net income, among other key financials, for a given accounting period. Practically speaking, the P&L statement helps demonstrate a company’s results of operations and operational efficiency, which can be useful for predicting future success.

What Is a Profit and Loss Statement?

A profit and loss statement, formally known as an income statement or simply as a P&L, tracks the amount of profit that remains after a business subtracts all of its costs from its revenue during a specific accounting period, typically monthly, quarterly and annually. Profit is also referred to as net income or net profit and appears on the last line of a P&L — hence the nickname: the bottom line. But between total revenue and net income is other important financial data that not only can help explain business performance but also identify areas of strength and those in need of improvement. Public companies operating in Australia are required to prepare and lodge their profit and loss statements (opens in new tab) with the Australian Securities and Investments Commission (ASIC), in accordance with the Australian Accounting Standards (opens in new tab) (AAS), which are set by the Australian Accounting Standards Board (AASB) and meet the requirements of the International Financial Reporting Standards (opens in new tab) (IFRS), except for a minority of cases where a company may qualify for an exemption. While small proprietary companies do not have to prepare or send financial statements to ASIC, they too can benefit from tracking this financial data.

Key Takeaways

• A profit and loss statement includes a business’s total revenue, expenses, gains, and losses, arriving at net income for a specific accounting period.
• Management analyses a P&L to determine how to increase profitability by increasing revenue, lowering costs, or both. A P&L is also a useful tool for lenders and investors that are evaluating a business for a loan or investment.
• A profit and loss statement is prepared using one of two accounting methods: cash or accrual.

Profit and Loss Statement Explained

A profit and loss statement demonstrates the results of operations for a fiscal period, reflecting revenue, expenses, and profitability. When revenue exceeds expenses, the result is net income, commonly called profit. The higher its profit, the better the business’s ability to grow, invest in operations, attract financing, receive loans, and reward shareholders. When costs surpass revenue, it’s called a net loss.

Profit is calculated by adding and subtracting various expenses and income from a company’s total revenue, which is also known as the top line because it appears at the top of the P&L. The items deducted from revenue are the cost of goods and services (COGS), operating and nonoperating expenses, and taxes. Non operating income — such as interest income from bank accounts — is added to the total amount. The result is the company’s profit or loss.

By following income statement data over time, managers can uncover areas in need of improvement and more accurately forecast future financial performance. For example, an unusually high increase in the cost of raw materials over a period may only become evident when a P&L is created. Profit and loss statements can also demonstrate to external parties, such as investors and lenders, that the company is profitable and where that profit comes from, which in turn is useful for determining whether the company is worthy of an investment or loan.

How Profit and Loss (P&L) Statements Work

A profit and loss statement showcases a company’s revenue and expenses; the more detailed it is, the more useful it can be to anyone inside or outside the business who wants a handle on the inner workings that begin with revenue and culminate in a net profit or loss. There are several types of P&Ls that range in the level of detail provided. For example, a simple P&L typically provides a basic summary of financial data for a high-level overview of profits and losses, while a more detailed P&L may include granular data, such as a breakdown of sales and expenses by product line. (More on this later.) Also noteworthy: P&Ls typically show comparative financials from previous periods — typically year over year — so analysts can compare changes in profits and losses over time.

As noted earlier, a profit and loss statement is one of three main financial statements that are generated monthly, quarterly and annually. Together they form a full picture of a company’s financial well-being. The other two statement are:

• The cash flow statement, which reveals a company’s ability to convert assets to cash, referred to as liquidity. More specifically, the cash flow statement lists the amount of cash and cash equivalents that flowed into and out of the business over a specific period from operating, investing, and financing activities.
• The balance sheet, which presents a cumulative snapshot of a business’s financial position, including assets, liabilities and equity at a point in time, usually the end of an accounting period.

Basic P&L Formula

The profit and loss statement is based on a simple formula that begins with total revenue from sales for a particular accounting period. Other income from non-core (ancillary) business activities, such as interest income, are added to revenue, as are gains from non-recurring transactions, such as the sale of equipment for more than its carrying value. Expenses related to business activities and losses related to noncore activities, such as a lawsuit payout, are subtracted. The result is net income, which indicates whether the business was profitable.

The basic formula to determine net income is:

Net income = revenue – expenses + gains – losses

For example, let’s say at the end of a fiscal year a business earned $675,000 in revenue from sales and generated $35,000 from the sale of a fully depreciated asset. The latter is a gain. During that same year, the business had $400,000 worth of expenses — most related to COGS — plus another $55,000 in ancillary losses. Using the P&L formula, net income can be calculated like this:

Net income = revenue – expenses + gains – losses
($675,000 – $400,000 + $35,000 – $55,000)
Net income = = $255,000

What the Profit and Loss Statement Shows

A P&L is typically broken into several sections. The top section lists net sales followed by the cost of goods sold (an expense). The difference between them is called gross profit, and it represents how much money is left after the business has paid all of its direct expenses. Simpler P&Ls may list COGS on one line, whereas others may break it down into specific categories, such as raw materials and labour.

The next section lists all operating expenses, which are not directly related to the production of goods but are necessary for the business to operate. They include administrative fees, office supplies, advertising, and insurance. These expenses are subtracted from gross profit to arrive at operating income — also referred to as earnings before interest and taxes (EBIT) — which assesses a business’s operating profitability. Managers tend to have more control over their operating expenses than cost of goods sold, which is dependent on external factors beyond their control, such as the price of raw materials.

Other miscellaneous financial gains and losses are listed next. Gains can include lawsuit settlements in the business’s favour and the sale of assets above their net carrying value. Losses can include the same, only in the form of outbound payments, such as for a lawsuit settlement paid out by the business and sales of assets below their carrying value. The result is income before taxes, also known as earnings before taxes (EBT), after which taxes are deducted to arrive at net income. Net income can be distributed to owners, used to pay down liabilities or retained and used to grow the business.

Components of a Profit and Loss Statement

Profit and loss statements can vary in detail and be organised however it makes the most sense for a company, depending on the type of analysis that a business plans to perform, and which standards and information are required by who it’s being submitted to. For example, accounting in construction businesses will likely have different expense categories than in law firms, and their P&Ls will reflect those differences. However, some common line items in a business’s profit and loss statement include:

• Revenue: The top line of the P&L is net sales from goods or services. This amount also reflects returns, discounts and other changes made during the sales process. More detailed P&Ls may show gross revenue and the various deductions to get to net revenue, or they may segment revenue by product or service type or other criteria set by the business.
• COGS: The cost of goods and services sold includes all the direct costs required to produce products or deliver services. Acquisition of raw materials, storage costs, parts used in manufacturing and labor are some items that are included in COGS. It may also include depreciation of manufacturing equipment, depending on the accounting method used to create the P&L. (More on this soon.)
• Gross profit: Gross profit, also known as gross income, is determined by subtracting COGS from revenue to reveal profitability from a business’s core operations. Without gross profit, a business won’t have the funds needed to cover its expenses, such as operating expenses and taxes.
• Operating expenses: These are the costs to run a business that aren’t involved in the production of a good or service. Operating expenses, such as selling, general and administrative expenses (SG&A), include corporate office utilities, rent, salaries, marketing and shipping.
• Earnings before interest and taxes (EBIT): EBIT, also called operating income, is calculated by subtracting all operating expenses from gross profit. EBIT is a crucial profitability measure used to show the income from a business’s core operations.
• Non-operating expenses: These are miscellaneous expenses and one-off losses outside of the business’s core activities, including interest payments, sales of old and depreciated assets or lawsuit settlements, all of which influence income and cash flow.
• Earnings before taxes (EBT): EBT is determined after all gains are added to and losses are subtracted from EBIT. EBT is a useful measure for comparing similar businesses’ performance.
• Net income: Net income is the last line of the P&L — calculated after taxes are deducted. This “kitchen sink” calculation is often the first place that investors and lenders look to assess a company’s fiscal health.
• Earnings per share (EPS): For public companies, EPS is calculated by dividing net income by the number of shares outstanding. Investors use this figure to help decide whether they want to invest in a company.

Types of Profit and Loss Statements

A profit and loss statement typically follows one of several common formats, which depends upon the size of the company, complexity of business operations, and reporting requirements. It’s important to choose the right type of P&L that accurately reflects business operations, provides sufficient information on, and meets reporting requirements. Some common types of P&Ls are:

• Single-step: A single-step profit and loss statement reports all revenue items in one group and all expenses in another group to arrive at net income in a single calculation.
• Multistep: A multistep profit and loss statement is more detailed and contains separate sections for operating and non-operating activities. It also includes intermediate totals — gross and operating profits, for example — to provide more granular insight at each step of operations.
• Condensed: A condensed profit and loss statement is a shorter version of multistep statements that summarise expenses into categories. Additional details are often included in supplemental reports instead of on the P&L itself. 
• Common-size: A common-size statement converts every line on the profit and loss statement — regardless of the type of P&L used — into a percentage of total revenue for easier side-by-side comparisons with other businesses. This isn’t required by AAS, but rather is used internally for managers’ analysis or externally to compare different companies.

However, one of the primary differences among profit and loss statements isn’t detectable just by looking at the statements. Rather, it’s recognised by analysing the methodology used to create them — the cash method versus the accrual method which can have a big impact on how and when profit is measured. AAS-compliant financial statements will disclose the accounting methodologies used in the footnotes to the P&L.

Cash Method

The cash method recognises revenue and expenses when cash is received from customers or paid out by the business, regardless of when a sale was made or the bill was received. This method is the simpler of the two and is primarily used by smaller, private businesses, but it’s not AAS-compliant.

Accrual Method

Public companies are required to use the accrual method, per AAS, in which they record revenue when earned, even if the customer buys on credit and does not have to pay their bill until a later date. This concept, known as revenue recognition, tends to provide a more accurate view of a business’s operations because it bypasses the impact of payment timing that can muddy the view of when a business is actually conducting its core function — selling its goods or services. Similarly, expenses are recognised in the same period as incurred and COGS are recognised in the same period as the applicable revenue — this is known as the matching principle. For example, advertising expenses incurred in the third quarter are recognised then, regardless of when they are actually paid.

Profit and Loss Statement Examples

Below are three sample profit and loss statements, all for the same accounting period for fictional company “Mike’s Music Shop Inc.” The first is an example of a condensed P&L, the second a single-step P&L and the third a multistep P&L.

Single-Step Profit and Loss Statement

Multistep Profit and Loss Statement

Condensed Profit and Loss Statement

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A profit and loss statement is one of three primary financial statements that all companies should prepare and update on a regular basis, and Australian companies are required to submit them annually, within four months after the end of the financial year, or within three months for disclosing companies. The P&L focuses on a business’s total revenue and gains, less expenses and losses, to determine whether it was profitable for a specific accounting period. If it was, the business will have earnings left over to distribute to shareholders, pay down its debts and reinvest in the business to grow. This is also a positive sign of financial health to third parties, including investors and lenders. Internally, a profit and loss statement provides managers and decision-makers with insight into a company’s profitability, factoring for a variety of costs and expenses incurred along the way. Using this data over time, managers can spot areas for improvement — such as growing revenue or a cost-cutting measure — and more accurately forecast future performance.

Profit and Loss Statement FAQs

What is in a profit and loss statement?

A profit and loss statement (P&L) statement includes a business’s revenue, cost of goods and services sold, operating expenses, interest, taxes, net income and any other gains and losses. Revenue is known as the top line, and net income is called the bottom line.

Can I do my own profit and loss statement?

You can, but whether you should depends on the financial complexities of your business. Even the smallest of businesses that first create their P&Ls manually soon hand the job over to software, noting greater accuracy, timeliness, and speed.

What is profit and loss with an example?

Profit and loss statements come in several forms — condensed, single-step and multistep — all leading to net income. A condensed profit and loss statement presents summaries of revenue and expense categories. A single-step P&L only requires a single calculation to determine net income. A multistep P&L goes into greater detail about income and expenses than the others. A version of any of these formats that adds a column to convert each line into a percentage of revenue is referred to as a common-size P&L.

What is the difference between a profit and loss statement and a balance sheet?

A profit and loss statement and a balance sheet are two core financial statements that businesses generate monthly, quarterly, and annually. A balance sheet lists a company’s assets, liabilities, and equity at a point in time. A profit and loss statement lists revenue, profits, expenses and other gains and losses over the course of a fiscal period.

Do all companies have to prepare a profit and loss statement?

Australian public companies are required to prepare and submit a profit and loss statement with the Australian Securities and Investments Commission and in adherence to the International Financial Reporting Standards. Still, small proprietary companies can benefit from regular preparation and analysis of their own profit and loss reports. 

Why is a profit and loss statement important?

A profit and loss statement provides managers and decision-makers with insight into a company’s profitability, factoring for a variety of costs and expenses incurred along the way. Using this data over time, managers can spot areas for improvement — such as growing revenue or a cost-cutting measure — and more accurately forecast future performance. External parties, such as investors and lenders, also turn to a company’s profit and loss statement to determine whether it’s worthy of an investment or loan.

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