A profit and loss statement is one of the most important financial statements a small business can prepare. While not a legal requirement for non-incorporated companies, it is an extremely useful tool for improving transparency when it comes to your finances. It can help SMEs better understand their operating cash flow. Along with the cash flow statement and balance sheet, it is one of the three financial statements that incorporated companies must make public.
A company’s profit and loss statement details the revenue, capital expenditure and operational expenses incurred during a given period. It is usually created on a quarterly or annual basis. Generating a profit and loss statement helps a company to see how well it is building its profit margin by increasing revenue and/or reducing expenses.
Comparing profit and loss statements from different accounting periods can also help companies track the effects of cost-cutting or revenue-building activities over time.
Profit and loss statement example
The profit and loss statement is known by several names, including:
- income statement
- earnings statement
- expense statement
- statement of operations
- statement of financial results
There is no specific format that a profit and loss statement needs to take. Every company will have a slightly different statement depending on their business model, and the time period covered by the report.
There are many examples of figures that may be included, such as:
- sales of goods and services
- sales of financial products
- cost of goods sold
- selling, administrative, and general costs
- interest expense
- research and development expense
- provision for income tax
Cash method vs accrual method
Profit and loss statements can be presented on a cash or accrual basis.
The cash accounting method means that transactions are only recorded when cash is received or paid. Transactions are recorded as revenue when cash is incoming and as liabilities cash is outgoing. Due to its simplicity, this method is often favoured by smaller businesses and sole traders.
The accrual method, on the other hand, records revenue when it is earned, even if payment has not yet been received. Likewise, liabilities are logged as soon as invoices are received and not necessarily when funds are outgoing.
Frequently asked questions about profit and loss statements
What is the difference between a profit and loss statement and a balance sheet?
A balance sheet shares many similarities with a profit and loss statement. However, it is more of a snapshot of a company’s financial health and is not necessarily useful for tracking financial trends. A balance sheet is principally used by stakeholders and prospective investors to gauge the number and quality of a company’s assets and liabilities.
Why are profit and loss statements important?
Profit and loss statements can be a useful tool for both business owners and outside analysts to gauge the long-term profitability and viability of a company. It can help businesses to measure the effects of their operational strategies on their finances, and inform their ongoing strategies. What’s more, profit and loss statements are a legal requirement for incorporated companies in the US.
Is a profit and loss statement a legal requirement?
Incorporated businesses in the US are legally required to produce a profit and loss statement for every financial year. Publicly traded companies are also required to submit their cash flow statement and balance sheet.
If you are not trading as a limited company, there is no legal requirement to create this financial statement. However, it is good practice to do so anyway, as the information it requires is the same information that you will need to report to either the SEC or HMRC anyway.