The profit and loss (P&L) statement (also known as an income statement) is one of the four basic financial statements that presents the revenues, expenses, and net income of a business. In basic accounting, the P&L statement is always one of the first financial statements to be prepared. It measures the performance and profitability of a company and guides business owners in making revenue growth and cost control decisions. Easily generate an income statement with the right accounting software. Our guide on the best small business accounting software can help you choose the best software for your small business needs.
Types of P&L Statements
P&L or income statements are presented using the multiple-step or single-step approach. Regardless of the type, the net income figure stays the same. However, the format heavily impacts the kind of information you can get from the income statement.
Multiple-step P&L Statement
The multiple-step income statement reports income and expenses in two sections: operating and nonoperating.
- Operating: Reports revenues and expenses pertaining to the company’s primary operations, such as selling farming supplies and providing consulting services
- Nonoperating: Reports only the secondary or auxiliary activities of the company, such as rent income or interest income, and shows the extraordinary and infrequent gains and losses that are unrelated to the business’s main activities
This approach to preparing the income statement also uses the function of the expense method, which presents expenses based on its function, such as cost of goods sold (COGS), selling expense, and general expense. Below is an example of a multiple-step income statement from Pym Cosmetics, a fictitious company selling makeup and hair products.
PYM COSMETICS Income Statement For the Year Ended December 31, 2022 | ||
|---|---|---|
Sales Sales revenue Sales discounts Sales returns and allowances | $ 5,789,487 (231,579) (115,790) | |
Net Sales | 5,442,118 | |
Cost of Goods Sold | (3,374,113) | |
Gross Profit | 2,068,005 | |
Operating Expenses | ||
Selling Expenses Sales salaries and commissions Sales office salaries Delivery expense Advertising expense Depreciation of sales equipment Telecommunication expense Postage and stationery | 268,841 227,481 179,916 144,785 9,005 7,496 6,214 | (843,738) |
Administrative Expenses Officers' salaries expense Office salaries Legal and professional expense Utilities expense Building depreciation Office equipment depreciation Postage and stationery Miscellaneous office expense | 197,432 177,300 23,721 22,375 17,401 15,978 7,745 3,004 | (464,956) |
Income from Operations Other Revenue and Gains Dividend revenue Interest income Rent income Other Expenses and losses Interest expense Loss on sale of equipment | 85,000 12,000 20,000 278,631 2,034 | 759,311 117,000 (280,665) |
Income Before Tax Income Tax | 595,646 125,086 | |
NET INCOME | $ 470,560 | |
Earnings per share | $ 2.353 | |
Single-step P&L Statement
The single-step approach reports all revenues and expenses as a lump—it doesn’t classify these items by function or operating vs nonoperating. It uses the nature of expense method, reporting expenses by type, like utilities, instead of functional purpose. If we convert the income statement above using the single-step approach, it should look like this:
PYM COSMETICS Income Statement For the Year Ended December 31, 2022 | ||
|---|---|---|
Revenues Sales Dividend revenue Interest income Rent income | $ 5,789,487 85,000 12,000 20,000 | |
Total Revenues | 5,906,487 | |
Expenses Cost of Goods Sold Sales discounts Sales returns and allowances Sales salaries and commissions Sales office salaries Delivery expense Advertising expense Depreciation of sales equipment Telecommunication expense Postage and stationery Officers' salaries expense Office salaries Legal and professional expense Utilities expense Building depreciation Office equipment depreciation Postage and stationery Miscellaneous office expense Interest expense Loss on sale of equipment | (3,374,113) (231,579) (115,790) (268,841) (227,481) (179,916) (144,785) (9,005) (7,496) (6,214) (197,432) (177,300) (23,721) (22,375) (17,401) (15,978) (7,745) (3,004) (278,631) (2,034) | |
Total Expenses | (5,310,841) | |
Income before tax Income tax | $ 595,646 $ 125,086 | |
NET INCOME | $ 470,560 | |
Earnings per share | $ 2.353 | |
Uses of a P&L Statement
For small businesses, the income statement can be a useful financial statement to assess their performance in implementing short-term and long-term goals:
- Evaluate past performance: You can use the income statement to evaluate your performance in achieving business objectives. For example, if your goal is to increase sales by 20%, you can compare the current year’s P&L statement with the previous year’s statement to assess if you achieved this goal.
- Predict future performance: You can use income statements of the past years to perform a trend analysis. By looking at how income and expense moved through the years, you can predict growths and declines by looking at changes in income and expense amounts.
- Assess the relationship between future cash flows and revenues: While the income statement uses the accrual basis, you can still use this statement to assess the relationship of revenues with cash flow. For example, you can compare income from operations with the operating cash flow in the cash flow statement. In this comparison, you can analyze the speed at which operating income becomes cash.
Learn more about small business bookkeeping and how a bookkeeping system can help your business organize accounting information.
Analyzing the P&L Statement
There are two ways to analyze the P&L statement: common size analysis and year-over-year (YoY) analysis.
PYM COSMETICS Income Statement For the Years Ending December 31 | |||||
|---|---|---|---|---|---|
2022 | % | 2021 | % | % Δ YoY | |
Sales | |||||
Sales revenue | $ 5,789,487 | 100.00% | $ 5,347,895 | 100.00% | ▲ 8.26% |
Sales discounts | (231,579) | -4.00% | (359,913) | -6.73% | ▼ -35.66% |
Sales returns and allowances | (115,790) | -2.00% | (177,550) | -3.32% | ▼ -34.78% |
Net Sales Cost of Goods Sold | 5,442,118 (3,374,113) | 94.00% -58.28% | 4,810,432 2,948,795) | 89.95 -55.14% | ▲ 13.13% ▲ 14.42% |
Gross Profit | 2,068,005 | 35.72% | 1,861,637 | 34.81% | ▲ 11.09% |
Operating Expenses | |||||
Selling Expenses Sales salaries and commissions | (268,841) | -4.64% | (268,841) | -5.03% | ▲ 0.00% |
Sales office salaries | (227,481) | -3.93% | (130,315) | -2.44% | ▲ 74.56% |
Delivery expense | (179,916) | -3.11% | (111,698) | -2.09% | ▲ 61.07% |
Advertising expense | (144,785) | -2.50% | (97,421) | -1.82% | ▲ 48.62% |
Depreciation of sales equipment | (9,005) | -0.16% | (8,400) | -0.16% | ▲ 7.20% |
Telecommunication | (7,496) | -0.13% | (6,500) | -0.12% | ▲ 15.32% |
Postage and stationery | (6,214) | -0.13% | (7,118) | -0.13% | ▼ -12.70% |
(843,738) | 14.57% | (630,293) | -11.79% | ▲ 33.86% | |
Administrative Expenses | |||||
Officers' salaries expense | (197,432) | -3.41% | (187,362) | -3.50% | ▲ 5.37% |
Office salaries | (177,300) | -3.06% | (200,142) | -3.74% | ▼ -11.41% |
Legal and professional expense | (23,721) | -0.41% | (27,463) | -0.51% | ▼ -13.63% |
Utilities expense | (22,375) | -0.39% | (20,447) | -0.38% | ▲ 9.43% |
Building depreciation | (17,401) | -0.30% | (17,600) | -0.33% | ▼ -1.13% |
Office equipment depreciation | (15,978) | -0.28% | (15,998) | -0.30% | ▼ -0.13% |
Postage and stationery | (7,745) | -0.13% | (7,941) | -0.15% | ▼ -2.47% |
Miscellaneous office expense | (3,004) | -0.05% | (1,179) | -0.02% | ▲ 154.79% |
(464,956) | -8.03% | (478,132) | -8.94% | ▼ -2.76% | |
Income from Operations | 759,311 | 13.12% | 753,212 | 14.08% | |
Other Revenue and Gains | |||||
Dividend revenue | 85,000 | 1.47% | 30,000 | 0.56% | ▲ 183.33% |
Interest income | 12,000 | 0.21% | 6,000 | 0.11% | ▲ 100.00% |
Rent income | 20,000 | 0.35% | 15,000 | 0.28% | ▲ 33.33% |
117,000 | 2.02% | 51,000 | 0.95% | ▲ 129.41% | |
Other Expenses and losses | |||||
Interest expense | (278,631) | -4.81% | (172,553) | -3.23% | ▲ 61.48% |
Loss on sale of equipment | (2,034) | -0.04% | - | 0.00% | |
(280,665) | -4.85% | (172,553) | -3.23% | ▲ 62.65% | |
Income Before Tax | 595,646 | 10.29% | 631,659 | 11.81% | ▼ -5.70% |
Income Tax | (125,086) | -2.16% | (132,648) | -2.48% | ▼ -5.70% |
NET INCOME | $ 470,560 | 8.13% | $ 499,011 | 9.33% | ▼ -5.70% |
Earnings per share | $ 2.353 | $ 2.495 | ▼ -5.70% | ||
To analyze the sample income statement analysis above, we can use both ways:
- Common size analysis: With this method, you state income and expenses as a portion of total sales rather than just large figures. For example, you can look at the difference between the gross profit margin of 35.72% and operating profit margin of 13.12%. We can analyze these two by investigating why operating expenses ate 22.6% of gross profit. Is the business using too many resources? Are there unnecessary expenses in the business’s operations? These are just some of the points of analysis you can derive using the common size approach.
- YoY or trend analysis: Here, we compare the same line item but at different periods to see whether it increased or decreased. Take a look at the % Δ YoY―read as “percentage change year-over-year”―column in the example above. We can see that 2022 saw an 8.26% increase in sales revenue. While that is good, it’s also worth noting that 2022 net income decreased by 5.70%. Even with a considerable increase in sales, why did the profit margin decrease? A possible explanation for this is rising costs. If you look at the cost of goods sold and selling expenses above, it’s up by 14.42% and 33.86% in 2022, respectively. Now, you can dig deeper into why COGS and selling expenses are rising. Is it because of internal factors, such as spoilages and unexpected overhead costs, or external factors like rising inflation and rising oil prices?
Limitations of a P&L Statement
A P&L statement can help you measure profitability and performance. However, it cannot provide a 100% prediction or explanation. The primary limitation is that the income statement uses the accrual basis of accounting, which does a good job of matching expenses with the revenues they generate but doesn’t provide information on whether your business is generating sufficient cash flow.
The secondary limitation is the use of estimates and accounting methods. For example, depreciation expense only estimates the useful life of an asset. Moreover, some companies may choose different depreciation methods for different classes of assets. Other companies with similar assets might estimate the useful lives differently, making the income statement incomparable.
Bottom Line
The profit and loss statement is the primary statement that every business owner must examine to assess if the business is operating efficiently, such as getting high revenues at the least possible cost and time, and effectively, such as achieving revenue goals that put the company at a better position. However, always proceed with caution when analyzing the income statement because it has its limitations as well.
