P&L 101: What are Profit & Loss Reports and How Should you Read Them?

The Profit & Loss (P&L) report is a window into your business, providing a means to seeing how your money comes in and where it is spent. The main premise of this report is to understand how your business either earned a net profit or loss and how to modify your strategy. Love it or hate it, the P&L report is the scorecard of a company – and if you can read it well, it can help your company grow sustainably.

P&L reports are used to track a business’s total revenue and total expenses in a specific period of time, usually prepared monthly or quarterly. As it demonstrates a business’s net profit (or loss), it can indicate the strength of a company’s operations and sales strategy.

The main categories that can be found in the P&L report include:

  • Revenue (or Sales)
  • Cost of Goods Sold (or Cost of Sales) – COGS
  • Operational Expenses
    • Selling, General & Administrative (SG&A)
    • Marketing & Advertising
    • Technology
    • Interest Expense
    • Taxes
  • Net Income (Profit)

There are three main sections of a P&L statement: revenues, COGS and operational expenses. Any listed line item on a P&L goes under either revenue or an expense account, and all these items determine the bottom line.

To go a little deeper, there are a few types of profit:

1. Gross Margin in a P&L Report

A company’s gross margin is its profit before operating expenses. The gross margin reflects the core profitability of a company before overhead costs and shows the financial success of a product or service. It is also used to calculate the gross margin ratio, which is found by dividing the gross margin by the total revenue. Calculating the gross profit margin allows you to compare similar companies to each other and the industry as a whole to determine relative profitability.

Gross Margin = Revenue – COGS

2. EBITDA in a P&L Report

EBITDA (Earnings Before Interest, Tax, Depreciation & Amortization) is a metric that closely resembles free cash flow for most businesses. By looking at earnings and adding back interest, tax and depreciation expenses, a company can see what could be available as cash. Since depreciation and amortization are non-cash items, they do not have to do with the health of a business’s cash flow. Therefore, EBITDA is a good way to gauge cash flow in your P&L report.

3. Net Profit in a P&L Report

The net profit is the ultimate measure of the profits of a business. Taking a company’s revenue and subtracting COGS and all operational expenses result in a number that is a business’s net profit.

One important thing to keep in mind while making your P&L report is the difference between an income statement and a balance sheet. While they are different, they each complement one another to form a bigger picture. An income statement shows how profitable a business is over a given period, while the balance sheet gives a snapshot of assets and liabilities. Together, they make a strong financial duo.

Understanding an organization’s income statement is essential for all businesses to analyze profitability and growth. Luckily, the basic equations underlying income statements are easy to break down, and all statements are organized in similar ways.

To learn more or for help with your P&L report, please contact our team of expert outsourced accountants.

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