Understanding Profit and Loss Report

The profit performance reports that are prepared by business managers around the world are better known as profit and loss reports, or simply P&L reports. There is no fixed timing of their preparation; the teams can create them whenever the managers are in need of this analysis; it may be on a monthly basis or quarterly as well.

The profit and loss statement is also named as an income statement or in some cases, statement of operation. This report is a summary of expenses, revenues and profits or losses of the respective company. P&L Report is prepared on the basis of set accounting principles and it includes details about matching, revenue generation and accruals as well. Important to mention that it is different from the general cash flow statement.

Understanding Profit and Loss Report

Firstly, a profit and loss account is called other names; income statement, earnings statement, revenue statement, or an operating statement. Every public company must release the profit and loss statement along with the cash-flow statement and balance sheet annually. In the profit and loss account, you’ll find the revenues, expenses and profit or losses over a specified period. In precise terms, the profit and loss account explicitly state a company’s ability to generate sales, manage expenses and the possibility of profit or loss. Profit and loss account is guided by accounting principles such as revenue recognition, accruals, and matching.

A profit and loss account is prepared over a specified time frame; monthly, quarterly, bi-annually or annually. Regardless of the organization, a profit and loss account is built upon the simple accounting formula;

Structure of the profit and loss report:

There are so many important elements of this report. It can be designed on a quarterly basis, monthly or as per the fiscal years. Some of the most important categories of this report include:

  • Net income
  • Taxes
  • Interest expense
  • Technology
  • Advertising and marketing
  • Selling, general and administrative expenses
  • Cost of Goods sold
  • Revenue

SALES – COST= PROFIT OR LOSS

Both sales and cost are given different names in the profit and loss account. This makes the preparation of the profit and loss account difficult for anyone without an accounting training. However, this can be surmounted through online accounting software which is already built to recognize revenue sources and expenses.

The beauty of a profit and loss account lies in its ability to spell out in figures areas of success and struggle in the business. Through this, business owners and managers can monitor the activity of the company and proffer solutions in the event of a loss. For an investor or a prospective investor, the profit and loss account give them a clear picture of the financial health of your company. It gives them the financial standing of your business.

Every profit and loss is segmented into revenue and expenses. The revenue of your firm provides a detailed explanation of the income from all primary and secondary activities the business is involved in. This is also the case for the expenses which can either be primary or secondary. Of course, the most critical revenue that will determine your profit or loss is the income generated from sales as other secondary income can be unpredictable. Growth in your business will be a reflection of the revenue generated from sales.

For the expenses, two items must stand out; the cost of goods sold and the operating expenses. Through a cloud accounting software, you can monitor the cost and look into areas where you can reduce the cost to increase profits. For example, when you compute your profit and loss account using myBooks online accounting software, you can ascertain how much you are spending on raw materials. This will let you know if you need to change to another supplier to tackle cost.

Whichever online accounting software for small business you are using, it will provide the following metrics that will be utilized by your financial analysts;

  • Year over Year Numbers (Horizontal analysis)
  • Trend analysis
  • Gross profit margin, Operating margins, net profit margin and EBITDA margin
  • Valuation Metrics
  • Rates of return

Profit and loss report is beyond the numbers, and it tells all the story that needs to be known about the business. Through a profit and loss account, you are able to make crucial business decisions.

Impact of accountability principles:

As we already stated that this report is prepared as per the specific accounting principles; but you cannot observe the impact by just viewing the report. However, the final figure that is written at the bottom of the report may vary as per the total amount of money lost or made.

Some of the most important aspects that have a considerable impact on this report are:

  • Revenue recognition principle:

In general terms, revenue can be better defined as the cash received by the company. It is accountable for the accounts receivable and is placed on the balance sheet.

  • Matching principle:

Expenses are directly matched to the generated revenues, and they are evaluated during the entire period for which revenue is earned.

  • Accrual principle:

The expenditure and income must be recorded right when they occur; not when the cash comes in hand. This evaluation has a significant impact on the overall cash flow.

Analysing profit loss statement:

Every company has a profit loss analyst or simply the financial analyst who observes the P&L reports to make future recommendations for the better health of the finances in the company. The analysis of P & L statement includes:

  • Valuation of some important metrics such as price to book, P/E ratio, and EV/EBITDA etc.
  • Rates of return: Return on assets and return on equity.
  • Observation of margins: Net profit margin, operating margin, EBITDA margin and gross profit margin.
  • Comparison of the numbers over the years along with industry benchmarks.

Things to look while preparing a profit and loss report:

Those who are creating profit and loss report for the first time may need some guidance on how to do it right. Here are a few tips:

  • Choose the specific time frame.
  • List overall revenue of your business for that duration.
  • Calculate the overall expenses of your business for that duration.
  • Determine gross profit.
  • Analyse if you are making profits.