A small business owner may have many aims, but if those aims do not include and result in profits, no business will remain. As renowned auto industry executive Lee Iacocca said, “In the end, all business operations can be reduced to three words: people, product and profits.” One of the keys to achieving and maintaining profits is the effective use of and knowing how to read a profit and loss statement.     

What is a Profit and Loss Statement       

A profit and loss statement is a financial document that summarizes the total income of a business, along with all its expenses during a specific period, resulting in a profit or loss during that period. The profit and loss statement (P&L) is also called an income statement, statement of financial performance, or operating statement. It is one of three critical documents used to guide a business in addition to the cash flow statement and the balance sheet.

Why is a Profit and Loss Statement Matters 

A profit and loss statement serves as an indicator of the financial health of a business. It provides a way for a business owner to see how profitable his/her business is and how much money is left after expenses and losses are accounted for. In addition to its usefulness to owners and internal management, it is also used by lenders, investors, and analysts to assess the financial strength and profitability of a business. Knowing where a business stands financially can mean the difference between success and failure for any business.

How to Read a Profit and Loss Statement 

Components of a P&L:

The key components of a profit and loss statement include: 

  • Revenues.  
  • Cost of goods sold.  
  • Operating expenses.  
  • Non-operating expenses.  
  • Gross profit. 
  • Earnings before interest and taxes (EBIT). 
  • Earnings before taxes. 
  • Net income–the “bottom line” of the P&L.                

Steps to Read a P&L:                           

Follow these steps to read and analyze a profit and loss statement for each reporting period: 

  1. Define all aspects of revenue. If there are separate revenue streams, separate them. Reviewing sales (revenues) first is important because that is the primary way to improve profitability. Consider sources of revenue and seasonality in your analysis. 
  2. Define and understand all components of the cost of goods sold and all other expenses. 
  3. Calculate the gross margin which is the direct costs subtracted from revenue. That figure shows how much money is available for operating expenses and revenue-generating expenses. 
  4. Calculate the operating income which is the income or earnings before interest, taxes, and depreciation. 
  5. Examine the budget versus actual figures to see how well a business is doing compared to its performance plan. 
  6. Look at the year-over-year figures to see how well the performance of the business compares to the prior year. 
  7. Determine the net profit and compare that to cash flow figures to fully explain a company’s health. 
  8. Review net income as a percentage of sales—your profit margin. This provides a helpful comparison across time periods and against other competitors.                        

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