The other main business report is the profit and loss statement. This report is a sum¬mary of the income and expenses of the business during a certain period. Profit and loss statements are sometimes referred to as income statements or operating statements. You may choose to prepare a profit and loss statement monthly, quarterly, or annually, depending on your particular needs. You will, at a minimum, need to have an annual profit and loss statement in order to streamline your tax return preparation.
A profit and loss statement, however, provides much more than assistance in easing your tax preparation burdens. It allows you to clearly view the performance of your business over a particular time period. As you begin to collect a series of profit and loss statements, you will be able to conduct various analyses of your business. For example, you will be able to compare monthly performances over a single year to determine which month was the best or worst for your business. Quarterly results will also be able to be contrasted. The comparison of several annual expense and revenue figures will allow you to judge the growth or shrinkage of your business over time. Numerous other comparisons are possible, depending on your particular business. How have sales been influenced by advertising expenses? Are production costs higher this quarter than last? Do seasons have an impact on sales? Are certain expenses becoming a burden on the business? The profit and loss statement is one of the key financial statements for the analysis of your business.
Generally, income for a business is any money that it has received or will receive dur¬ing a certain period. Expenses are any money that it has paid or will pay out during a certain period. Simply put, if the business has more income than expenses during a certain period, it has made a profit. If it has more expenses than income, then the busi¬ness has a loss for that period of time.
Income can be broken down into two basic types: service income and sales income. The difference between the two types of income lies in the need to consider inven¬tory costs. Service income is income derived from performing a service for someone (cutting hair, for example). Sales income is revenue derived from selling a product of some type. With service income, the profit can be determined simply by deducting the expenses that are associated with making the income. With sales income, however, in addition to deducting the expenses of making the income, the cost of the product that was sold must also be taken into account. This is done through inventory costs. Thus, for sales income, the income from selling a product is actually the sales income minus the cost of the product to the seller. This inventory cost is referred to as the cost of goods sold.
A profit and loss statement begins with a sale. Back to the food business as an example: Smith had the following transactions during the month of July: $250.00 worth of food was sold, the wholesale cost of the food that was sold was $50.00, the cost of napkins, condiments, other supplies, and rent amounted to $100.00, and interest payments on the equipment loan were $50.00. Thus, Smith’s profit and loss statement would be prepared as follows:
Gross sales income $ 250.00
– Cost of food $ 50.00
= Net sales income $ 200.00
Operating expenses $ 100.00
+ Interest payments $ 50.00
= Net expenses $ 150.00
Thus, for the month of July, Smith’s business performed as follows:
Net sales income $ 200.00
– Net expenses $ 150.00
= Net profit $ 50.00
Again, this simple setup reflects the basics of profit and loss statements for all types of businesses, no matter what their size. For a pure service business, with no inventory of any type sold to customers: income – expenses = net profit. For a sales-type business or a sales/service combined business: income – cost of goods sold – expenses = profit.
These two types of summary reports—the balance sheet and the profit and loss state¬ment—are the basic tools for understanding the financial health of any business. The figures on them can be used for many purposes to understand the operations of a busi¬ness. The balance sheet shows what proportion of a business’s assets are actually owned by the business owner and what proportion is owned or owed to someone else.
Looking at Smith’s balance sheet, we can see that the owner’s equity is $1,670.00 of assets of $2,070.00. Thus, we can see that the owner has more than 80 percent own¬ership of the business, a very healthy situation. There are numerous ways to analyze the figures on these two financial statements. Understanding what these figures mean and how they represent the health of a business are keys to keeping control of the finances of any business.
© Nova Publishing Company, 2005