How to Make a Profit and Loss Statement (With Example)

A profit and loss statement (P&L, also called an income statement) shows whether a business made money over a period: a month, a quarter or a year. It starts with what customers paid, subtracts what it cost to earn and run the business, and ends with net income. Lenders, investors and tax preparers ask for it, and it’s the report owners look at most.

The structure

A P&L always reads from top to bottom in the same order:

1. Revenue (sales, service income), less returns and discounts, gives net revenue.
2. Cost of goods sold (COGS): the direct cost of what was sold. Materials, inventory, subcontractors, shipping to customers.
3. Net revenue minus COGS is gross profit. Divided by net revenue, it’s the gross margin.
4. Operating expenses: rent, payroll, software, advertising, insurance, and everything else needed to run the business.
5. Gross profit minus operating expenses is operating income.
6. Other income and expenses: interest earned or paid, gains or losses on selling equipment.
7. The result is net income (or net loss) before income tax. Corporations then show their income tax expense; for sole proprietors and pass-through entities, tax is paid by the owners and doesn’t appear on the business P&L.

A worked example

A small design studio’s P&L for the first quarter:

	Amount
Revenue	84,000
Less: refunds and discounts	(1,200)
Net revenue	82,800
Cost of goods sold: subcontractors and printing	(31,500)
Gross profit (62.0% margin)	51,300
Rent	6,000
Payroll and payroll taxes	22,400
Software and subscriptions	1,150
Advertising	2,300
Insurance	1,050
Depreciation	900
Total operating expenses	(33,800)
Operating income	17,500
Interest expense	(350)
Net income	17,150

Read it from the bottom up: the studio kept $17,150 of the $82,800 it billed, a net margin of about 20.7%. The gross margin shows that subcontractors take more than a third of every dollar of sales, the first place to look if the owner wants to improve profit.

Step by step

1. Choose the period and make sure every transaction in it is recorded: bank and card accounts reconciled, invoices and bills entered.
2. Choose cash or accrual. On the cash basis, income counts when it’s received and expenses when they’re paid. On the accrual basis, income counts when it’s earned (invoiced) and expenses when they’re incurred (billed), whether or not money moved. Use the same basis as the tax return, and say which one the report uses.
3. Total each income account for the period, then subtract returns and discounts.
4. Total the COGS accounts. Businesses with inventory compute COGS as beginning inventory plus purchases minus ending inventory, so count stock at period end.
5. Total each expense account. Group small accounts into a few readable lines if the report is for an owner or a lender.
6. Add the subtotals in the order above, and check that net income matches your accounting software’s report for the same period and basis.
7. Compare. A single P&L says little. Put it next to the same period last year, or the previous month, and look at what changed.

The free profit and loss template adds the subtotals and margins for you, compares two periods side by side, and exports Excel or PDF.

What doesn’t belong on the P&L

These are the most common mistakes, and each one makes profit look wrong:

• Owner draws or distributions. They’re payments to the owners, recorded in equity. They don’t reduce profit.
• Loan principal. Only the interest is an expense. Repaying the principal reduces the loan on the balance sheet.
• Buying equipment. A laptop or a vehicle is usually an asset, spread over its useful life through depreciation. The P&L shows the depreciation, not the purchase price. Follow your tax preparer’s policy for small purchases.
• Sales tax collected. It belongs to the state and sits in a liability account until it’s paid. Revenue excludes it.
• Transfers between your own accounts, such as moving money from checking to savings. They’re neither income nor expense.
• Loans received. Borrowed money is a liability, not revenue.

The P&L and the other statements

The P&L shows performance over a period. The balance sheet shows what the business owns and owes on the last day of that period, and net income flows into its equity section. The cash flow statement explains why the bank balance changed, which is often very different from profit on the accrual basis: a profitable month with slow-paying customers can still drain cash.

To see how much revenue the business needs just to cover its fixed costs, use the break-even calculator with the fixed expenses from your P&L and the price and direct cost of a typical sale.