Regardless of whether you are seeking financial aid from a bank or other lending institution for your small business startup, you will require a number of financial statements that are critical to decision-making.
Of utmost importance is the Profit and Loss statement, also known as a “P&L” or an income statement. This document presents a clear picture of your business’s revenues, expenses, and, consequently, the profit or loss. It covers a specific timeframe, which could be a month, a quarter, or a year.
When Should a Profit and Loss Statement Be Prepared?
A Profit and Loss (P&L) statement should be prepared and reviewed regularly by every business, ideally on a quarterly basis. This periodic evaluation assists in making informed business decisions and aids in the preparation of the business tax return. The information derived from the P&L statement serves as the basis for calculating net income and determining the income tax payable by the business.
New businesses should also create a P&L statement at the inception stage. This initial statement is typically projected or pro format, offering a forecast into the future. Furthermore, a pro forma P&L is also required when seeking funding for any new business projects.
What Data is Needed to Compile a Profit and Loss Statement?
To prepare a Profit and Loss statement, you require specific financial data, most of which can be derived from your first-year monthly budget or cash flow statement. Additionally, you would need information regarding depreciation, which can be estimated in consultation with your tax advisor.
In terms of specifics, you will need a list of all transactions that occurred in your business checking account and all the purchases made with your business credit cards. Do not forget to include any petty cash transactions or other cash transactions for which you have receipts.
Your income data should include a list of all income sources, such as checks, credit card payments, and so on. These details are typically found on your bank statement. You would also need to consider any reductions in sales, like discounts or returns.
Even though using business accounting software simplifies the process with its standard report generation feature that includes the P&L statement, it is still critical to understand the information required to compile this report.
Incorporating Cash Transactions into Your Profit and Loss Statement
An important aspect to remember while preparing your Profit and Loss statement is the inclusion of all cash transactions. This is applicable to both income and expenses. Even when utilizing business accounting software, there may be a need to manually input certain cash transactions.
These might encompass petty cash disbursements and cash-based income. If your business collects cash from customers, consider using a cash transaction form available at office supply stores or a simplified tax invoice template.
For any cash expenditures, make sure you retain the receipts. These receipts are particularly essential for documenting business-related driving and meal expenses.
Crafting a Pro Forma Profit and Loss Statement
When embarking on a new business venture, actual financial data necessary for a genuine P&L statement is typically unavailable. As a result, assumptions and educated guesses come into play, resulting in a pro forma or projected P&L statement.
It’s common practice to draft a pro forma statement for each month of the inaugural business year. However, potential lenders might request more months or even years to be included in this projection, highlighting the point where your business achieves consistent positive cash flow, i.e., the break-even point.
- Categorize and list all conceivable expenses, leaning towards overestimation to guard against unforeseen costs. Don’t overlook incorporating a ‘miscellaneous’ category and allocating an appropriate monetary amount to it.
- Forecast your monthly sales figures. It’s prudent to underestimate both the timing and the quantity to maintain a realistic outlook.
- Typically, the difference between expenses and sales is negative for an initial period. Accumulating these negative values will give you a ballpark figure of how much capital you might need to borrow to kickstart your business.
Drafting a Regular Profit and Loss Statement
The procedure and information required for compiling a Profit and Loss statement remain consistent, irrespective of whether the statement is for a startup, tax preparation, or business analysis. Each row on the statement will represent a quarterly amount, with a total for the year at the end.
Commence by showcasing your business’s net income for each quarter of the year, commonly labeled as “Sales.” You may opt to further breakdown this income into sub-sections, detailing income from various sources.
Following this, delineate your business expenses for each quarter, depicting each expense as a percentage of Sales with the total expenses amounting to 100% of Sales. The difference between Sales and Expenses signifies Earnings, often referred to as EBITDA (earnings before interest, taxes, depreciation, and amortization).
Subsequently, display the total annual interest on your business debt and subtract it from EBITDA. Next, list the estimated taxes on net income and subtract. Lastly, illustrate the total depreciation and amortization for the year and subtract it. The remaining figure represents net earnings, demonstrating your business’s profit or loss.
Conclusion
Preparing a Profit and Loss statement, whether pro forma or regular, offers crucial insights into the financial health of your business. It empowers you with the necessary information to make strategic decisions, seek funding, or prepare for tax season. Remember, this document is not a mere formality but a compass guiding your business to sustainable profitability.
Regular update and review of your P&L statement strengthens your understanding of the financial trajectory and assists in making calculated, data-driven decisions that align with your business’s long-term goals.