Profit and Loss (PNL): A Comprehensive Guide [August 2023]

Profit and loss (PNL) statements are vital in the world of finance. They provide a comprehensive overview of a company’s financial performance, including its revenue, expenses, and profits over a specific period.

By looking at PNL statements, businesses can evaluate their financial health, make informed business decisions, and identify areas for improvement.

Some commonly asked questions about PNL statements include: “What is PNL?”, “What is the difference between revenue and net income?” and “How can I use a PNL statement to make informed business decisions?“.

All those questions will be clarified in today’s article. Let’s dive in!

What Is PNL?

PNL statements, also known as income statements, are financial documents that show a company’s revenue, cost of goods sold, gross profit, operating expenses, operating profit, and net profit.

• What is PNL: An abbreviation for “Profit and Loss“, also known as “P&L”.

• What it tracks: Earned money vs spent money.

• What it informs: if you run at a profit or a loss throughout that time.

  

A profit and loss statement summarizes all the activity recorded in your income and expenses accounts over the specified time. Income typically includes sales while expenses might cover things like payroll, advertising, rent, and insurance.

The statement will include all sales, including credit sales that your customers might not have paid yet. It will also include bills for expenses that you have incurred but not paid.

Your total profit or loss is what you’ve earned minus what you’ve spent:

• If this amount is positive, it’s called net income.
• If it’s negative, it’s called a net loss.

These statements are prepared at the end of a company’s financial period, be it monthly, quarterly, or annually. They are used to evaluate a company’s financial performance, make informed business decisions, and identify areas for improvement.

❗A PNL statement can also help you calculate profit margin and displays how well the business is converting revenue into profits.

💡Learn more: Profit vs Revenue: All The Differences Explained 20+ eCommerce Metrics Every Store Must Track Frequently Customer Profitability Analysis: Definition, Formula & Benefits

Importance Of PNL In Business

Following the definition, PNL statements are an essential tool for businesses looking to evaluate their financial performance, make informed business decisions, and identify areas for improvement.

By analyzing revenue, expenses, and profits, businesses can gain a comprehensive understanding of their operations and make informed decisions about future goals.

Profit and loss statements are important for businesses because they:

• Evaluate financial performance: Offer insights into a company’s financial health, including revenue, expenses, and profits.
• Make informed business decisions: Helps businesses make strategic decisions, such as increasing revenue or cutting expenses.
• Identify areas for improvement: Businesses can identify areas for improvement.
• Assess financial health and potential for growth: Assess a company’s financial health and potential for growth.
• Identify risks and opportunities for growth: Highlight potential risks and opportunities for growth.
• Track financial progress over time: Comparing PNL statements from different periods helps businesses track their financial progress over time.
• Provide insights into financial performance: Offer valuable insights into a company’s financial performance.
• Help businesses make informed decisions: Provide essential information for businesses to make informed decisions about future goals and strategies.

Overall, these statements are a crucial part of firm financial management, offering insightful information about financial performance and assisting organizations in making defensible choices regarding their long-term objectives and strategies.

PNL Statement Structure

Now you’ve known the basics about PNL, let’s deep dive into its components. A profit and loss statement contains several components that provide an overview of a company’s financial performance. These components can be grouped into two categories:

To accurately assess a company’s financial performance, you need to understand these 6 important components:

1. Revenue

This is the overall revenue a business generates from its activities. It stands for the monetary influx brought about by the selling of products or services. Because it sheds light on a company’s sales success, revenue is an essential part of a PNL statement.

For example, suppose your store attracted: April: $5.500 May: $6.800 June: $9.700 Then your total revenue in Q2 is $22.000.

2. Cost of Goods Sold  (COGS)

This indicates the costs a business expended in creating the products or services it sold. Raw material expenses, direct labor charges, and other direct expenditures are included. A crucial part of a PNL statement is COGS since it sheds light on a company’s manufacturing expenses.

Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory

3. Gross Profit

The distinction between revenue and COGS is as follows. It shows how much money a business has made after deducting the cost of making the sold items or services. A crucial part of a PNL statement is the gross profit since it sheds light on how well a firm produces its goods.

Gross Profit = Revenue – COGS

4. Operating Expenses

These are the expenses incurred by a company in running its day-to-day operations. Operating expenses are a critical component of a Profit and loss statement because they provide insights into a company’s operating efficiency. Examples include salaries, rent, utilities, and marketing expenses.

5. Operating Profit

This is the difference between gross profit and operating expenses. It represents the amount of money a company has earned after deducting the cost of running its day-to-day operations. Operating profit is a critical component of the statement because it provides insights into a company’s operating efficiency and overall profitability.

Operating Profit = (Revenue – COGS) – Operating Costs

6. Net Profit

This is the total amount of money left over after deducting all expenses from revenue. It represents the overall profitability of the company. Net profit is a critical component of a PNL statement because it provides insights into a company’s overall financial health.

Net Profit = Operating Profit – (Debt Interest + Taxes)

For businesses to get insights into their financial performance and pinpoint areas for development, understanding these fundamental elements of a PNL statement is crucial.

These elements can be examined by firms to help them comprehend their revenue streams, production costs, and running expenses so they can decide on their financial objectives and strategies with confidence.

Risk Factors Impact The PNL

1. Changes in Market Demand

If demand decreases, the company may experience a decline in revenue, which can negatively impact the PNL. On the other hand, if demand increases, the company may experience an increase in revenue, leading to a positive impact on the statements.

2. Increases in Production Costs

PNL can be affected if production costs increase, such as materials or labor. This can lead to a decrease in profits, which can negatively impact the overall profit and loss. Companies need to be cautious when making decisions that can lead to increased production costs, as it can impact their bottom line.

3. Changes in the Regulatory Environment

Companies need to stay up to date with changes in the regulatory environment to ensure they are operating in compliance with regulations.

For example, new taxes or regulations can result in increased costs for the company, which can negatively impact the PNL.

4. Fluctuations in Currency Exchange Rates

This affects especially if the company has operations in multiple countries. If the currency exchange rate changes, it can impact the company’s revenue and expenses, leading to a positive or negative impact, depending on the direction of the change.

5. Natural Disasters/Unforeseen Events

In rare cases, some events can disrupt business operations, impacting the company’s financial performance. These circumstances are uncontrollable and unpredictable, most of the time.

For example, if a company’s production facility is damaged by a natural disaster, it can lead to a delay in production, and a decrease in revenue, which can negatively impact the PNL.

How to Create A Profit and Loss (PNL) Statement

A P&L statement can be created in one of two ways: The cash method and the accrual technique.

1. Accumulated accounting (Cash method)

The Cash method is used to record transactions when they occur, regardless of whether cash has been received or paid. This method is used by most businesses as it provides a more accurate picture of a company’s financial performance.

2. Cash accounting (Accrual method)

The Accrual method is used to record transactions when cash is received or paid, regardless of when the transaction occurred. This method is typically used by small businesses or those that do not have complex financial transactions. While the cash accounting method is relatively simple, it can provide an inaccurate picture of a company’s financial performance.

❗Carefully consider which accounting method they choose to use. While the accumulated accounting method provides a more accurate picture of financial performance, it can also be more complex and time-consuming to implement. The cash accounting method, on the other hand, is simpler and easier to implement, but may not provide as accurate a picture of a company’s financial performance.

Businesses should also be aware that while preparing PNL statements, there are additional aspects to take into account, such as tax rules and regulations, industry standards, and the unique requirements of the firm. As a result, it’s crucial to get the advice of a financial expert or accountant while creating PNL statements to verify that the statements are correct and adhere to all applicable rules and regulations.

3. Create PNL Statements Automatically with TrueProfit

If you’re doing your business on Shopify, you can also use third-party applications like TrueProfit.

Why? Because TrueProfit is the ultimate Profit Analytics Platform for Shopify, giving merchants the complete big picture of how well their businesses are running. With rich features regarding product analytics, profit analytics, and above all, an in-depth PNL report, TrueProfit is essentially everything you need to know your Net Profit or in other words, your True bottom line in real-time.

Let’s take a look at a P&L report made by TrueProfit. Basically, you can see all the ins and outs of your biz in one single dashboard. 

Users of TrueProfit can monitor their profit margins, determine which of their items are the most profitable, and improve their pricing strategies to boost profits. Store owners may use TrueProfit to receive insightful information about their financial performance and make wiser business decisions.

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How to Use PNL Statements Effectively

To use PNL statements effectively, businesses can take the following steps:

1. Set goals: Such as increasing revenue or reducing expenses. This helps businesses track their progress toward goals and stay focused.
2. Monitor progress: Regularly review statements to identify areas for improvement and ensure progress toward financial objectives.
3. Analyze trends: Compare statements over time to identify trends and make informed decisions to achieve financial goals.
4. Use benchmarks: Compare financial performance to industry benchmarks to identify areas for improvement and stay competitive.
5. Seek professional advice: Consult with an accountant or finance professional for accurate statements and expert advice on improving financial performance.
6. Use PNL statements with other financial documents: Get a complete picture of financial health and make informed decisions.

Some Commonly Asked Questions About PNL Statements

1. Is PNL the same as an Income Statement?

Profit and loss statements and income statements are the same thing. They both provide a comprehensive overview of a company’s financial performance, including its revenue, expenses, and profits over a specific period.

2. What is the difference between a PNL and a Balance Sheet?

Profit and loss statements show a company’s revenue, expenses, and profits over a specific period.

The balance sheet shows a company’s assets, liabilities, and equity at a specific point in time.

Simply put, A balance sheet gives a snapshot of a company’s financial position, while a PNL statement shows how well the company is performing financially over some time.

By understanding the differences between these statements, businesses can gain a more complete picture of their financial health and make better-informed decisions.

3. Is it mandatory to prepare a PNL statement?

While there is no legal requirement to prepare a PNL statement, it is a vital financial document that businesses should prepare to evaluate their financial performance and make informed business decisions.

A well-prepared PNL statement can provide insight into how the company is performing financially, which can be useful for identifying areas for improvement or potential cost-saving measures.

Additionally, having a PNL statement can be helpful when seeking financing or investors because it shows that the company is taking its financial performance seriously. Investors and lenders often require financial statements, including PNL statements, to assess a company’s financial health and potential for growth.

4. Who prepares the Profit and Loss statement?

The PNL statement is typically prepared by an accountant or finance professional within the company. However, small businesses or startups may prepare their PNL statements using accounting software.

It is important to ensure that whoever is preparing the statement understands accounting principles and uses accurate and up-to-date financial information. The statement should be prepared by the generally accepted accounting principles (GAAP) and should include all relevant financial transactions.

Having the statement reviewed by several persons can also be beneficial in ensuring its accuracy and spotting any potential mistakes or opportunities for improvement. Businesses can make sure the statement is accurate and offers useful insights into the company’s financial performance by having it reviewed by several experts.

Final Thoughts

Wrapping up, preparing PNL statements can be a complex process. Businesses need to ensure that they accurately account for all revenue and expenses over the specific period they are statementing on.

Through this comprehensive guide, businesses can set themselves up for success and achieve their financial goals. Moreover, it is crucial to ensure that they use appropriate accounting methods and practices to avoid misrepresenting their financial performance.

Using PNL statements effectively can help businesses gain a deeper understanding of their financial performance, make informed business decisions, and identify areas for improvement.

We hope you found this post helpful. Stay tuned for more exciting content coming soon on TrueProfit Blog!

Discover what proper profit-tracking looks like at trueprofit.io