What a Profit & Loss Report Tells You

A P&L (“Profit & Loss Report”, sometimes “Income Statement”) is a financial reporting document which shows specific types of financial information about a business. The purpose of this article is to summarize the fundamentals about the content and use of this report.

Overview

A P&L can be loosely compared to a “movie” of the financial status of a business. Like a movie, a P&L records financial activity from a specific starting point to a specific ending point. For example: for a month, for a quarter, or for a year. What are the things that are reported for the specified period?

• Revenues

• Direct Operating Expenses

• Overhead Expenses

• Profit or Loss

Revenues

Revenues are funds earned by the business for its work. These can be “sales”, “fees”, “commissions”, and other such categories of income to a business. Money coming into the business that is not included in revenues includes bank loan proceeds, equity capital investments received, and owner loans. These received funds are recorded as Balance Sheet transactions.

Direct Operating Expenses

Direct Operating Expenses (sometimes called “Cost of Sales” or “Cost of Goods Sold”) are the expenses that are directly related to the generation of revenues. Examples of such expenses would include:

• Merchandise sold

• Payroll for staff working on selling, building, and otherwise doing work that directly leads to revenues

• Supplies spent on jobs

• Equipment rental specifically for jobs

• Hiring subcontractors to work on projects

Revenues minus the Direct Operating Expenses yields what is usually called “Gross Profit” or “Gross Margin”. These numbers tell the owner(s) and other stakeholders in the business how much is spent directly on creating the revenues earned by the business. This amount varies greatly depending upon the nature of the business, but it is very important to track, over time, the ratio of these expenses to revenues so that any changes can be quickly spotted and analyzed.

Overhead Expenses

Overhead expenses are costs that are necessary for generation of revenues, but only in an indirect, longer term way. Think of them as expenses that would be paid, regardless of the level of revenues. Examples would include:

• Office staff payroll and related expenses

• Employee benefits

• Office facilities (rent, telephone, office supplies, computer maintenance, postage, etc.)

• Outside services (legal, accounting, etc.)

• Other expenses (taxes & licenses, interest, insurance, bank charges, etc.)

• Calculated expenses (depreciation and amortization)

The ratio of overhead expenses to revenue, and trends of the various overhead categories over time are vital tracking points for successfully (and profitably) managing a business.

Profit or Loss

Revenues, minus Direct Operating Expenses, minus Overhead Expenses yields the Profit or Loss earned by the business. This calculation, accurately determined, provides the most important single evaluation factor to the managers of the business, and also to bankers, investors, and other stakeholders in the success of the business. In addition, it is the key element in determining the income taxes to be paid.

Summary

When you look at a P&L you see the financial activity of a business over a specified period of time. You see revenues generated, spending to generate the revenues, relationships among financial categories, whether the business is profitable, and other key financial information about the business. The P&L should enable analysis of operations over time to spot trends or problems, to plan for the future, and to reward success.

A good P&L is vital.