If you’re running a small business, you’re well aware that good tools make all the difference in how you spend your time, money, and energy. One of the best tools? A profit and loss (P&L) statement.

Also known as an income statement, a P&L gives you a clear picture of how much money your business is bringing in and how much is going out over a specific period of time. It’s like a snapshot of your financial performance and then some. You can use it to guide decisions, spot trends, and keep your operations on track.

While a P&L statement is crucial on its own, it’s just one star of the story we like to call Small Business Success. Supporting characters include the balance sheet (showing you what you own and owe) and the cash flow statement (which tracks the movement of cash in and out of your business).

And because every good story has a villain, let’s introduce ours: no P&L at all.

Because in business, ignoring your P&L is like skipping the script and hoping the ending works out just fine. Risky at best, and more often than not, just plain costly.

Keep reading to find out more about your favorite main character and how to seamlessly incorporate the P&L into your business story with Wave.

How do profit and loss (P&L) statements work?

A profit and loss statement is all about financial health. It shows a company’s gains and expenses over a set period of time.

But like we mentioned above, it doesn't work alone.

A profit and loss statement is part of a trifecta of financial statements that every public company must issue on a quarterly and annual basis. These statements include the following: balance sheet, cash flow statement, and the P&L report.

To create your P&L, you’ll follow a simple formula: Profit (or Loss) = Total Income – Total Expenses

• Start with your total income: This is all the money your business earned during the period. 
• Subtract your expenses: This is everything your business spent to operate. For example: rent, marketing costs, wages, etc.
• ‍Calculate your net profit or loss: The number you’ll end up with is your profit or loss. If your income is higher than your expenses, that’s a profit. Expenses higher than income? That’s a loss.

Example: Profit and loss statement
‍More a visual learner? We’ve put together this example of a profit and loss statement, shown here.

What is a P&L statement used for? 

A P&L statement is a tool that helps you stay in control of your numbers and the financial health of your business. It gives you real insight into how your business is performing and where it might need attention. That’s why keeping it updated is critical.

For instance, if you’re looking to answer the question that’s always in the back of your mind—is my business actually making money—your P&L doesn't just give you a yes or no. It tells the whole story.

By comparing your income and expenses month-to-month or year-over-year, you’re able to track growth, identify trends, and measure the impact of your business decisions. Yes, even your decision to finally launch a TikTok account and a quirky mascot you can only hope will rival Duolingo’s iconic bird. (Good luck.)

In addition to uncovering the key plot points of your financial story, profit and loss statements can also help you simplify budgeting and planning. You can use it to help set realistic revenue goals, forecast expenses, and plan for upcoming investments, like equipment upgrades, hiring, or new marketing initiatives.

Profit and loss statements are also helpful for tax season. They organize your financial data in one place, making it simpler to file returns, claim deductions, and answer any questions from your accountant.

Last but not least, P&Ls are must-haves when communicating with investors. It shows that you understand your business, that you’re tracking its performance, and that you’re serious about making money (which can make them more serious about investing in you).

Profit and loss vs. other financial statements

The profit and loss statement is just one part of your financial toolkit.

While it shows how much money your business earned and spent over a specific time period, it works best when viewed alongside two other key reports: the balance sheet and the cash flow statement.

A balance sheet gives you a snapshot of your business’s financial position at a single moment in time. It shows what you own (assets) versus what you owe (liabilities), plus the equity you’ve built.

The cash flow statement tracks the actual movement of money in and out of your business. This might be from things like operations, investments, or financing.

In short, the following three statements give you the full story of your financial health:

• The P&L tracks income and expenses over time
• The balance sheet captures assets and liabilities at a specific point in time
• The cash flow statement reveals how money actually moves through your business

Keep reading for a more detailed breakdown.

P&L statement vs. balance sheet

Think of your P&L statement and balance sheet as two different snapshots of your business: one shows movement, the other shows position. A balance sheet captures the following three pieces:

• Everything your business owns (assets)
• Everything your business owes (liabilities)
• What’s left over for you (equity) at a specific point in time.

It’s like hitting pause and seeing exactly where you stand financially at any specific time.

In contrast, the P&L statement tells the story of how your business has performed over a set period, typically a month, quarter, or year. It focuses on income and expenses, showing whether you made a profit or took a loss during that time.

Think of it this way: while the balance sheet shows what you have, the P&L shows how you got there.

As we’ve outlined below, your P&L reflects all the income minus all the expenses for that period. It ‘bridges the gap’ between a balance sheet at the start of the period and a balance sheet at the end.

P&L statement vs. cash flow statement

While your P&L statement shows whether your business is profitable over time, the cash flow statement reveals how money actually moves in and out of your business.

For example: you’re a web designer who just landed your dream project. But just because the handshake was firm, it doesn’t mean you’ve got the cash in hand.

This is where your cash flow statement comes in.

It gives you a view of the cash that’s coming in and out of your business, helping you track liquidity and make sure you can cover your bills, payroll, and other obligations until those dollars come in. Which, if you use Wave, might be sooner than you think.

How to read a P&L statement (line-by-line guide)

Revenue

• Definition: This type of entry brings in your net sales (i.e. what’s leftover after deductions—like returns, allowances and discounts—that have been subtracted from gross sales) or receipts during the accounting period. It also includes the revenue earned from the primary operating activity of your business, plus non-operating revenue.
  
• Purpose: To see how much money you’re generating from your day-to-day operations
• ‍Examples: In the example of a freelance web designer, your revenue would come from (you guessed it) designing websites.

Cost of goods sold

• Definition: These are the direct costs tied to creating your product or delivering your service. Essentially, what you spend to do the work you get paid for. 
• Purpose: COGS helps you see how much money you're spending to get the job done. The higher this number, the more it eats into your profits. Yuck.
• ‍Example: If you’re a freelance web designer, your COGS might include software licenses (hi, Adobe), subcontractor fees for that *chef’s kiss* of a freelance copywriter you’ve hired, or templates you’ve purchased to help build the site.

Gross profit

• Definition: This is after you subtract your COGS from your total revenue: Revenue – COGS = Gross profit.
  
• Purpose: Gross profit tells you how much you’re actually earning from your services or products before overhead and other expenses come into play.
• Example: You’ve just charged $5,000 for a website, but spent $1,200 on a copywriter and design tools to complete it. In this scenario, your gross profit for the job would be $3,800.

Operating expenses

• Definition: These are the non-direct, day-to-day costs of running your business
• Purpose: Operating expenses are the funds you spend to keep the lights on (quite literally). Think of them as the “behind the scenes” support.
• ‍Example: Your office rent, payroll, internet bill, invoicing software that helps you stop chasing clients around and gets you paid fast and easily—you know, the good stuff.

Other expenses

• Definition: These are costs that aren’t part of your core operations. They might be a surprise cost or an infrequent expense. 
• Purpose: Although “other expenses” can be unexpected, unplanned, or infrequent, they can impact your bottom line. That’s why they’re important to track.‍
• Example: Were your taxes done by your best-friend’s sibling’s neighbour who’s “looking to get into the biz”? Gulp. You might be in for an unexpected tax bill at the end of the year. File that one under “Other expenses.”

Net income

• Definition: This is your actual profit. It’s what’s left over after all your expenses are paid. To get it, follow this formula: Gross profit – Operating expenses + Other income – Other expenses = Net income.
• Purpose: There’s a reason net income is called “bottom line”. It tells you if your business is actually making money once everything is tallied up.
• ‍Example: You’ve paid that surprise tax bill, all your software costs, office rent, and fees for your copywriter—and wow!—you still have $5,200 left at the end of the month. That’s your net income. And yes, you should be celebrating 🎉

How to prepare a profit and loss (P&L) statement

If you're not using super simple accounting software like Wave's, you can still prepare a P&L statement manually. Here’s a step-by-step breakdown to help you get started:

1. Add up your revenue: Calculate your total revenue for the time period you’re reviewing—this could be monthly, quarterly, or annually. Be sure to use your net sales, which means your gross sales minus any returns, discounts, or allowances.
   
2. Add up your COGS: Add the direct costs associated with running your business. For example: direct labor and materials costs, shipping and delivery fees, or things like production costs.
   
3. Calculate your gross profit: Subtract your COGS from your revenue. (Revenue – COGS = Gross profit).
   
4. Add up your operating and other expenses: List out all your operating expenses (the day-to-day costs of running your business that aren’t tied directly to production). This includes rent, wages, software subscriptions, utilities, and marketing. It can also include any non-operating expenses like loan interest or taxes.
5. Calculate your net profit (or loss): Finally, subtract your total expenses from your gross profit with this formula: Gross profit – Total expenses = Net profit.

Manually creating a P&L is a great way to get familiar with your numbers, especially when you're just starting out. But as your business grows, manual spreadsheets can get a little... messy.  Manual P&Ls can be time-consuming, prone to errors, and not exactly how you want to be spending your working hours (or your well-deserved time off).

The good news? Manual isn’t in the Wave vocabulary 🙌

Common mistakes to avoid

When preparing or reviewing your P&L statement, a few common slip-ups can throw off your numbers, especially if you’re doing things the old fashioned way—aka manually.

One of the biggest mistakes is mixing personal finances with your business ones. This makes tracking expenses and measuring profitability much harder.

Misclassifying expenses is another one to watch out for. This can lead to inaccurate totals and skewed insights. And don’t forget about tax liabilities. Overlooking them can make your profit look healthier than it really is. A little extra attention here can save you a lot of confusion and cleanup later.

Who should prepare a P&L and how often?

If you’re a small business owner or freelancer, reviewing your profit and loss (P&L) statement regularly isn’t just a good habit, it’s essential. Here are just two reasons why: 

• Control: Staying on top of your numbers means you’re in control of your business, with the insights to make smart decisions and plan for what’s ahead. Checking in on your P&L at least once a month (or even more often!) will help you track progress, catch issues early, and compare performance over time.
• Insight: It’s not just about knowing that you’re profitable—it’s about understanding how your profits are changing over time, and more importantly, what’s driving those changes.

But we get it. You’re busy and five steps to create a P&L statement can feel like a little too much in the too-little time you have. That’s where Wave can help.

With Wave, your P&L updates every time you record a transaction, so your financial picture is always up to date.

Profit and loss statement FAQs

Do all companies need to prepare P&L statements?

No, it’s not mandatory for private companies to prepare P&L statements, but publicly traded companies are required to do so.

That said, even small and private businesses still file them. They can be incredibly valuable, helping you monitor your financial health.

Moving ahead with profit and loss statements

Profit and loss statements are essential for understanding your business’s financial health.

Pair it with your cash flow statement and balance sheet, and you’ve got the full financial story of your business. And if you want to feel like a real P&L pro, layer in previous P&Ls to spot trends, identify red flags, and you’ll start forecasting like a wizard. It’s your data-driven crystal ball, helping you make informed decisions as your business grows.

Remember, while P&L statements aren’t always required (unless you’re a public company), they’re always useful, and when made with Wave, they’re easy.

Wave will generate your P&Ls, cash flow statements, and balance sheets all in one place. No spreadsheets. No off-hours work. Just total clarity.

Ready to make business decisions backed by real numbers and, better yet, to remove “manual math” off your already-packed agenda? Get started with Wave today.

P.S. Looking for the Oscar-worthy version of P&L statements? Take a look at our video to learn more about preparing your income statement, and what you can find when you do. 🔮