A profit and loss (P&L) statement, also known as an income statement, is one of the primary financial statements that you will use as a business owner. The main function of the profit and loss statement is to show the profitability of your company for the time period you specify. If your company is not operating profitably, you can use the P&L to gain an understanding of the revenue coming in and the expenses going out. It can help you pinpoint the financial trouble spots in your business so you can make adjustments to increase profitability. The complexity of your profit and loss statement will depend on your business, but there are some elements that are included on all P&Ls regardless of the size or age of the company.
The most basic definition of revenues is ‘money earned’. If you are using the accrual basis of accounting for your business, then you will record the revenues for your business on the P&L at the time the money is earned. The profit and loss statement records the transaction as revenue whether or not the money has been collected. For example, if a customer finances a purchase through your company, you record the revenue at the time of the purchase even though the customer will not pay for the item until a later date.
Your business can earn revenues through primary and secondary activities. If you own a restaurant, the primary activity you use to earn revenues is selling food to customers. If you own an extra office space that is connected to your restaurant, the rent you collect for that space is considered a secondary activity. It is revenue that is coming into your restaurant but it is not a direct result of selling food.
There are multiple categories of expenses for business owners, but the broad explanation is ‘any costs associated with the business.’ Expenses are recorded on the profit and loss statement at the time they are incurred but not necessarily when they are paid. For example, a salaried employee earns money each day at work but does not typically get paid immediately. On the profit and loss statement, you will record the expense of the employee salary when the employee earns the salary even though the money will be paid out on a later date.
Expenses can be incurred through primary and secondary activities which are also known as operating and nonoperating expenses. Operating expenses are any expenses that are related to the direct activity of the business. Employee salaries, rent, and utilities are all expenses that make it possible for you to run your business and provide your product or service to customers. A nonoperating expense is something that does not have a direct impact on the operation of the business such as interest on a business line of credit.
- Gains and Losses
You also record any gains or losses the business experiences during the reporting period on the profit and loss statement. For example, a gain or loss can occur when you sell an asset that the business owns. If you decide to sell an extra piece of real estate that your business owns, you will record that transaction on the P&L. If the piece of real estate brings more money than the business owes then you record that as a gain. However, if you sell the real estate for less than what the company owes or less than its recorded value, then you will report that transaction as a loss.
A profit and loss statement is an important tool for any business owner because it incorporates so much relevant information. By looking at and understanding your profit and loss statements, you can make changes that decrease expenses and increase profitability.