Starting a small business means being both an investor and an accountant. Managing your finances is part of the job. Even if you have a Certified Public Accountant (CPA), it’s good to know what reports and statements are prepared for your business.
A profit and loss statement, also known as an income statement, is one such report.
What is an income statement?
A profit and loss statement is a financial statement that summarizes your business’s income, costs, and expenses incurred during a given period (for example, a month, quarter, or year) and includes net profit.
If your company is listed on a stock exchange, financial statements including a profit and loss account, balance sheet, cash flow statement and statement of equity are included in the quarterly and annual reports that you must file for your company. Financial statements allow you and your shareholders to see business performance, providing a complete financial picture of your business.
Benefits of a profit and loss account
Preparing and viewing an income statement has many benefits, including:
- Get an overview of your company’s current profits for a period: With a profit and loss account, you can immediately see if your business is generating profits. When determining expenses, look for ways to reduce your business’s costs or increase its revenue.
- Compare your current profit and loss to past financial periods: Is your business growing? Are you increasing your profits? If yes, how long? It is useful to compare your current and past profit and loss statements to see where you can improve.
- Attract investors: New and existing investors will want to see periodic profit and loss statements to learn how your business is doing financially.
- Preparation for financing: If you’re applying for a business loan or want to finance new equipment, a bank will likely ask you to review your income statement.
You can ask your accountant to prepare a profit and loss statement for your business or you can create one yourself by following the steps below.
Gather what you need
Start by determining the period (eg, month, quarter, year) for which you want to prepare your profit and loss statement and the format you want to follow.
To prepare your profit and loss account, you will need to collect all financial transactions during this period, including:
- All sources of income; including sales, interest income, rental income and service charges and any reduction in sales, both returns and discounts.
- All expenses incurred such as purchases of materials and other assets, salaries (total compensation), interest charges on business loans, insurance, rent and taxes
Once you have your financial documents in order, follow the steps below to prepare your profit and loss statement.
Note that expenses are recognized when incurred, not when paid. Similarly, revenue is recognized when earned, not when cash is received.
Step 1: Determine your business revenue.
Add up all forms of income earned. Get all sales and returns from your general ledger, during the chosen time period (eg quarter).
Step 2: Calculate the cost of goods sold for your business.
Your total cost of goods sold can be calculated by taking your opening inventory, adding all purchases, freight, direct labor costs and a portion of indirect expenses and subtracting your ending inventory.
Step 3: Calculate the gross profit/loss of your business.
Gross Profit/Loss is calculated by subtracting Cost of Goods Sold (Step 2) from Total Revenue (Step 1).
Step 4: Determine your business operating expenses.
Calculate your business operating expenses by adding up all indirect business costs, such as:
- Administrative overhead
- Depreciation and amortization
Step 5: Calculate your business operating profit
Calculate your business’ operating profit/loss by subtracting operating expenses (step 4) from gross profit/loss (step 3).
Step 6: Determine any other income, other expense, interest income and interest expense.
Other income and other expense generally includes non-recurring items, for example, a gain or loss from the sale of an asset (eg, equipment).
Interest income includes any interest receivable, for example, on company cash held in bank accounts.
Interest expense includes any interest payable on business debts, for example, a business loan.
Step 7: Calculate your company’s tax liability.
The income tax expense for the period is calculated by multiplying the taxable income by the tax rate.
Step 8: Calculate your company’s bottom line.
To calculate net profit, also known as after-tax profit, take your operating profit (step 5) and add other income and interest income (step 6) and subtract other expenses and interest expense (step 6) and tax expenses (step 7) .
Net profit is commonly referred to as a company’s “bottom line” and is an indicator of a company’s profitability. Calculating net profit is the last step in preparing your income statement.
Now that you know how to prepare a profit and loss statement, find examples and templates online to help you get started.
Once you’ve prepared your profit and loss statement, use it to identify areas where you can improve the financial health of your business. Meet with your Chase Commercial Banker to determine if you are ready for a business bank account, need financing, or ready to apply for a business credit card.
For Informational/Educational Purposes Only: The opinions expressed in this article may differ from those of other employees and departments of JPMorgan Chase & Co. The opinions and strategies described may not be appropriate for everyone and may are not intended to constitute specific advice/recommendations for any individual. You should carefully consider your needs and goals before making any decisions and consult with the appropriate professional(s). Prospects and past performance are not indicative of future results.
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