How to Create a Profit and Loss Statement: The Complete Guide for Small Business Owners

If you run a small business and have never created a profit and loss statement, you are not alone. Nearly 42% of small business owners admit they had limited or no financial literacy when they started their companies. Yet understanding your P&L is one of the most critical skills you can develop—businesses led by financially literate owners are 30% less likely to fail in their first three years.

A profit and loss statement, sometimes called an income statement or P&L, answers the fundamental question every business owner needs to know: Am I making money or losing it? This guide walks you through exactly what a P&L statement is, how to create one, and how to use it to make better business decisions.

What Is a Profit and Loss Statement?

A profit and loss statement is a financial report that summarizes your business's revenues, expenses, and net income over a specific period—typically a month, quarter, or year. It tells you whether your business generated a profit or suffered a loss during that time.

The P&L is one of the three core financial statements every business needs, alongside the balance sheet and cash flow statement. While the balance sheet shows your financial position at a single point in time and the cash flow statement tracks money moving in and out, the P&L focuses specifically on profitability.

P&L Statement vs. Income Statement: Is There a Difference?

No. A profit and loss statement and an income statement are the same document. The terms are used interchangeably, though "income statement" tends to appear more often in formal financial reporting and audited financials, while "P&L" is common in small business settings and day-to-day operations.

You might also hear this report called a statement of operations or statement of revenue and expense. Regardless of the name, they all serve the same purpose: showing whether your business is profitable.

The Five Key Components of a P&L Statement

Every profit and loss statement contains the same core elements, organized from top to bottom:

1. Revenue (Sales)

This is your top line—the total income your business earned from selling goods or services. Revenue includes all sales before any expenses are deducted. If you run an e-commerce store, this is every dollar customers paid for products. If you are a consultant, it is every fee you collected for your services.

Some businesses break revenue into subcategories, such as product sales versus service revenue, or separate it by product line. This level of detail helps you understand which parts of your business generate the most income.

2. Cost of Goods Sold (COGS)

Cost of goods sold represents the direct costs required to create or deliver what you sell. For a product-based business, COGS includes raw materials, manufacturing labor, and shipping costs. For a service business, it might include contractor payments or direct labor costs.

COGS does not include indirect costs like rent, marketing, or administrative salaries—those fall under operating expenses.

3. Gross Profit

Gross profit is calculated by subtracting COGS from revenue:

Revenue - Cost of Goods Sold = Gross Profit

This figure shows how much money you have left after covering the direct costs of your products or services. Gross profit tells you whether your core business model is viable before accounting for overhead.

4. Operating Expenses (OPEX)

Operating expenses are the ongoing costs of running your business that are not directly tied to producing goods or services. Common operating expenses include:

• Rent and utilities
• Salaries and wages for administrative staff
• Marketing and advertising
• Software subscriptions
• Insurance
• Office supplies
• Professional services (accounting, legal)

Operating expenses are sometimes divided into selling expenses (costs related to making sales) and general and administrative expenses (overhead costs).

5. Net Income (Net Profit or Loss)

Net income is your bottom line—the profit remaining after subtracting all expenses from revenue:

Gross Profit - Operating Expenses - Other Expenses = Net Income

If this number is positive, your business made money during the period. If it is negative, you operated at a loss. Net income is the single most important number on your P&L because it represents what your business actually earned.

Single-Step vs. Multi-Step P&L Statements

There are two main formats for organizing a profit and loss statement:

Single-Step Method

A single-step income statement uses one calculation:

Total Revenues - Total Expenses = Net Income

This format groups all revenues together and all expenses together without distinguishing between different expense types. It is simpler and works well for small businesses with straightforward operations.

Multi-Step Method

A multi-step income statement separates expenses into categories and calculates multiple profit levels:

1. Gross Profit = Revenue - COGS
2. Operating Income = Gross Profit - Operating Expenses
3. Net Income = Operating Income - Non-Operating Items

The multi-step format provides more detail about where money is being made and lost. It helps you identify whether problems exist with your pricing (low gross profit), your overhead (high operating expenses), or other factors.

How to Create a Profit and Loss Statement

Here is a step-by-step process for creating your P&L:

Step 1: Choose Your Reporting Period

Decide whether you are creating a monthly, quarterly, or annual statement. Monthly statements give you the most timely information for making decisions, while annual statements are necessary for tax preparation and year-end analysis.

Step 2: Gather Your Financial Records

You need accurate records of all income and expenses for the period. This includes:

• Sales receipts and invoices
• Bank statements
• Credit card statements
• Payroll records
• Receipts for purchases and expenses

If you use accounting software, you can often export this data directly.

Step 3: Calculate Total Revenue

Add up all income from sales and services. Be sure to include only revenue earned during the reporting period, not deposits or payments for future work.

Step 4: Calculate Cost of Goods Sold

Identify all direct costs associated with your products or services. For product businesses, this includes inventory purchased, manufacturing costs, and direct labor. For service businesses, include contractor payments and direct service delivery costs.

Step 5: Calculate Gross Profit

Subtract COGS from total revenue. This tells you how much you have left to cover operating expenses and generate profit.

Step 6: List and Total Operating Expenses

Categorize and add up all business expenses not included in COGS. Common categories include:

• Rent and facilities
• Payroll and benefits
• Marketing
• Technology and software
• Insurance
• Professional services
• Travel and entertainment

Step 7: Calculate Net Income

Subtract total operating expenses from gross profit. Include any non-operating income (like interest earned) or expenses (like interest paid on loans) to arrive at your final net income.

Common P&L Mistakes to Avoid

Creating a P&L is straightforward, but several common errors can undermine its accuracy and usefulness:

Misclassifying Expenses

Putting expenses in the wrong category distorts your profitability analysis. For example, classifying direct labor as an operating expense rather than COGS will inflate your gross profit and hide problems with your production costs. Create a standardized chart of accounts and review classifications quarterly.

Not Tracking COGS Properly

Many business owners fail to track direct costs accurately, which makes gross profit meaningless. Be diligent about identifying which costs are truly direct versus indirect.

Ignoring Depreciation and Amortization

Not accounting for depreciation makes your net income appear higher than it actually is. If you own equipment, vehicles, or other assets, include depreciation as an expense to get an accurate picture of profitability.

Overlooking Non-Operating Expenses

Loan interest, one-time charges, and other non-operating items affect your bottom line. Include them to get a complete picture of your financial performance.

Reviewing Only Annually

Looking at your P&L once a year during tax season means small problems can grow into major issues. According to the Small Business Association, businesses that review financials only yearly have a 25-35% success rate, while those who review weekly have a 95% success rate.

Looking at Totals Only

Reviewing your P&L as a single set of numbers hides important patterns. Switch to monthly columns to see trends, seasonal variations, and emerging problems.

How Often Should You Review Your P&L?

The research is clear: more frequent reviews lead to better outcomes.

Monthly: Most accounting professionals recommend reviewing your P&L at least monthly. This frequency helps you catch issues like overspending or declining margins before they become serious.

Quarterly: Use quarterly reviews to evaluate trends, compare to the same period last year, and plan significant business changes.

Annually: Annual reviews are essential for tax preparation and strategic planning for the coming year.

What to Look for in Each Review

When you sit down with your P&L, ask these questions:

• Is revenue growing, flat, or declining compared to previous periods?
• Are profit margins holding steady or shrinking?
• Which expense categories are increasing fastest?
• How does this period compare to the same period last year?
• Are there any unusual items that need investigation?

Convert line items to percentages of revenue to spot changes more easily. If marketing costs jumped from 15% to 25% of revenue, that shift demands attention.

Using Your P&L to Make Better Decisions

A P&L statement is not just a historical record—it is a decision-making tool. Here is how to use it:

Identify Profitability Problems

If net income is negative or declining, your P&L helps pinpoint the cause. Low gross profit suggests problems with pricing or direct costs. High operating expenses point to overhead issues. Tracking these metrics over time reveals whether problems are getting better or worse.

Evaluate Pricing

Your gross profit margin (gross profit divided by revenue) tells you whether your pricing covers direct costs with room to spare. Industry benchmarks can help you assess whether your margins are competitive.

Control Expenses

Comparing operating expenses across periods highlights areas where spending is growing. You might find subscriptions you no longer need, marketing channels that are not performing, or opportunities to negotiate better rates with vendors.

Plan for Growth

Understanding your cost structure helps you forecast profitability at different revenue levels. If your operating expenses are mostly fixed, each additional sale contributes more to the bottom line. If they scale with revenue, growth requires more careful planning.

Secure Financing

Banks and investors will ask for your P&L when evaluating loan applications or investment opportunities. A history of profitability and well-organized financials improves your chances of approval and may earn you better terms.

Free P&L Statement Templates

You do not need expensive software to create a profit and loss statement. Free templates are available from many sources:

• Spreadsheet templates: Excel and Google Sheets templates let you customize categories and automate calculations
• Accounting software: Most small business accounting tools generate P&L statements automatically from your transaction data
• PDF templates: Simple fillable forms work for basic needs

When using templates, double-check formulas and review classifications carefully. One study found that 94% of business spreadsheets contain errors, so verification is essential.

Keep Your Finances Organized from Day One

Understanding your profit and loss statement is fundamental to running a successful business. But maintaining the accurate records needed to generate a reliable P&L requires consistent bookkeeping throughout the year—not just at tax time.

Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data. Every transaction is stored in a format you can read, search, and version control. Get started for free and take control of your business finances with accounting designed for clarity.