Profit and Loss Statement (P&L)

A profit and loss statement (P&L), also called an income statement, is a financial report that starts with a business's revenue for a period and subtracts its expenses in order to arrive at net profit or net loss. It is one of the core financial statements, and its job is to answer a single question over a stretch of time: did the business make money, and where did the money go on the way to that answer? Owners use it to manage, lenders and investors demand it before extending money, and it is the internal cousin of the tax return's profit-or-loss calculation.

A P&L is organized as a subtraction that runs down the page. It begins with revenue, subtracts the cost of goods sold to reach gross profit, subtracts operating expenses such as rent, wages, and marketing to reach operating income, and finally subtracts interest and taxes to reach net profit. Reading it from top to bottom shows not just whether a business made money but at which stage the money was made or lost, which is far more useful than the single final number alone.

The P&L is one of three financial statements and is easy to confuse with the other two. The balance sheet is a snapshot at one instant of what a business owns and owes, while the P&L covers a span of time; a P&L for the year and a balance sheet as of December 31 describe different things. The cash flow statement tracks the actual movement of cash, which, because a P&L is prepared on the accrual basis, can differ sharply from the profit the P&L reports. Together the three give a fuller picture than any one of them alone.

A business's internal P&L is not identical to what appears on its tax return. The tax version for a sole proprietor is Schedule C, which is essentially a profit-and-loss statement built on tax rules, and those rules diverge from ordinary accounting in places: depreciation schedules, the portion of meals that is deductible, and items that are expensed for the books but capitalized for tax. This is why a lender may ask for both the internal statements and the filed tax returns, and why the two can show different profit figures for the same year without either being wrong.

A P&L lists revenue at the top and works down through the layers of cost. Using hypothetical figures for a small landscaping business over one year:

Revenue is $150,000. Cost of goods sold, meaning the plants, materials, and crew labor tied directly to jobs, is $60,000, leaving gross profit of $90,000. Operating expenses, such as the truck, insurance, office costs, and advertising, total $55,000, leaving operating income of $35,000. Interest on a business loan and taxes come to $5,000, leaving net profit of $30,000.

Presented as a statement, those lines read: Revenue $150,000; Cost of goods sold ($60,000); Gross profit $90,000; Operating expenses ($55,000); Operating income $35,000; Interest and taxes ($5,000); Net profit $30,000. A reader can now see not only that the business cleared $30,000 but that its gross profit was healthy and most of the shrinkage came from operating costs.

Pros

• Shows profitability over a period and pinpoints, layer by layer, where money is made or lost.
• Is the document lenders and investors expect, so keeping one ready makes a business easier to finance.
• Built from ordinary bookkeeping, so a business with clean books can produce it at any time.

Cons

• Because it is prepared on the accrual basis, it can show a profit even when cash is tight, so it must be read alongside cash flow.
• It covers only a period and says nothing about what the business owns or owes, which is the balance sheet's job.
• The internal version can differ from the tax return, so the two must be reconciled rather than assumed identical.