The P&L, Line by Line

The Profit and Loss, also called the Income Statement, summarizes your sales and what it cost to create them over a period of time: usually a month, a quarter or a year. It's like a funnel: the numbers get smaller as you go down, from the Top Line, Revenue, to the Bottom Line, Net Income.

Net Income only exists on paper. It is not the same as cash. Unprofitable companies can be worth billions of dollars: Uber was, for years before its first profitable year. And profitable companies go bankrupt every day. Bankrupt doesn't mean you aren't profitable. It means you ran out of cash.

Think of the P&L as the past. Here is the sample company's month, then each line, top to bottom.

Revenue. Your income from sales. If you have annual subscriptions, only the part earned this month appears this month; the rest goes to Deferred Revenue on the Balance Sheet.

Bad Debt / Returns. The returns on your sales, plus the money from sales you expect never to collect. Retail businesses almost always have Returns; wholesale and consulting businesses may have Bad Debt.

Net Revenue. Revenue minus Bad Debt / Returns.

COGS (Cost of Goods Sold). The costs you incur when you make a sale, like the cost of your product. If you sell coffee, it's the beans and the cups. In a service business it can be the cost of your time, and then it's called Cost of Sales. This is different from Sales and Marketing Expenses, which you pay before making a sale and which don't track your sales one to one.

Gross Profit. Net Revenue minus COGS: how much you have left after making a sale. If Gross Profit is too low, there won't be enough to pay for Sales and Marketing and Operating Expenses.

Gross Margin. Gross Profit divided by Net Revenue, as a percentage. One of the most important ratios for judging whether a business can work. Ratios help because they let you compare businesses of different sizes.

Sales and Marketing Expenses. Pretty self-explanatory. As the old saying goes: "I know half of my advertising budget is wasted. I just don't know which half."

Operating Expenses. Also called Fixed Expenses. These are what you pay whether or not you make sales: salaries, rent, insurance, accounting. Many startups underestimate how many Operating Expenses they will have, and how big they'll be.

EBITDA. Earnings Before Interest, Taxes, Depreciation and Amortization, also called Operating Income.

EBITDA = Gross Profit − Sales and Marketing − Operating Expenses

Interest Expense. The interest on your loans. People often ask us why their loan payments don't appear on the P&L. Think back to the Lemonade Stand: the $15 from Mom wasn't part of Sales. Loans coming in or going out don't go on the P&L. The interest you pay does, because it's the cost of doing business with a loan.

Taxes. If your company is a C Corp, federal tax appears here as a flat 21% of Taxable Income (EBITDA minus Interest, Depreciation and Amortization). You may owe state taxes too. Losses in early periods, or in your historicals, offset later Taxable Income, so you may not see Taxes in your first profitable year.

Depreciation. Say you buy a fancy Italian lemon press for $5,000 that will last five years. Put the whole $5,000 on the P&L when you buy it and that year's profit looks worse than it really is. Since the press works for five years, we "Capitalize" it and put one fifth of the cost, $1,000, on each year's P&L. This doesn't change cash: you still spent the whole $5,000, as we'll see on Cash Flow.

Amortization. The same idea as Depreciation, for Intangible Assets like patents and trademarks.

Net Income / (Loss). Also called Profit, or Earnings. This is the Bottom Line.

Net Income = EBITDA − Interest − Taxes − Depreciation − Amortization

Profit Margin. Net Income divided by Revenue. EZ Numbers shows it when Net Income is positive.

Remember, Profit is not Cash! Net Income is a warm and fuzzy number that only exists on paper. To see your actual cash, you need the Cash Flow Statement.