Handbook / Bookkeeping and cash

Profit and loss statement for the self-employed: how to read and prepare one

A profit and loss statement, often called a P&L or income statement, shows whether your business made money over a period. It is the single most useful report for a self-employed person, and it mirrors the shape of the tax form most sole proprietors file. This guide explains what goes in it, how to read it, and how to use it.

What it shows

A P&L covers a period, such as a month, quarter or year:

1. Income: sales and fees earned.
2. Cost of goods sold, if you sell products: the direct cost of the items sold.
3. Gross profit: income minus cost of goods sold.
4. Expenses: operating costs grouped by category.
5. Net profit or loss: what is left.

Schedule C follows the same pattern: gross receipts, cost of goods sold, gross income, expenses, then net profit or loss. Keeping your books in this shape makes year-end filing straightforward.

A simple layout

For a solo service business, a monthly P&L might read:

• Income: service fees
• Less refunds
• Total income
• Expenses: advertising, contract labor, insurance, office, software, phone and internet, travel, vehicle
• Total expenses
• Net profit

The categories come from your chart of accounts, so a clean chart produces a readable P&L.

How to produce one

With software: categorise and reconcile your transactions, then run the profit and loss report for the period you want. Most tools also show comparisons.

With a spreadsheet: add up income and each expense category from your records for the period, and subtract.

Either way, the report is only as good as the bookkeeping behind it. Reconcile first.

Cash or accrual

Your accounting method affects the numbers. Under the cash method, income counts when received and expenses when paid. Under an accrual method, income counts when earned and expenses when incurred. IRS Publication 538 explains the rules. The guide on cash vs accrual covers which suits small businesses.

How to read it

Ask a few questions each month:

• Is income trending up, flat or down?
• What are the three largest expenses, and are they worth it?
• Did any category jump unexpectedly?
• What is the profit margin, net profit divided by income?

Compare with the previous month, the same month last year and your plan. Single months can mislead; year to date shows the bigger picture.

Profit is not cash

A profitable month can still leave you short of cash, and the reverse can happen. Reasons include:

• clients who have not paid yet under accrual accounting
• owner draws, which are not expenses
• loan principal repayments
• large purchases treated as assets
• taxes still to pay on the profit

For a sole proprietor, net profit is the basis for both income tax and self-employment tax. Your year-to-date profit is the number to use when checking how much to set aside for taxes.

Uses beyond tax

• Pricing decisions: low margins may mean prices are too low.
• Loans and leases: lenders often ask for recent statements.
• Planning: a year of P&Ls shows seasonality.
• Spending decisions: knowing your margin helps judge new costs.

Keep the records

The IRS expects records that clearly show income and expenses, with supporting documents. Save each year's annual P&L with your tax records alongside the receipts and statements behind it.

A worked example

Suppose a solo designer's March looks like this:

• service income: 6,000
• refunds: minus 200
• total income: 5,800
• expenses: software 150, contract labor 900, advertising 250, phone and internet 80, insurance 60
• total expenses: 1,440
• net profit: 4,360

The margin is about 75%. Comparing with February might show that contract labor jumped because of one large project, which is fine if that project's fee rose too. Comparing with last March might show income up but advertising flat, a sign that referrals are doing the work.

None of these insights need complex software, only consistent categories and a habit of looking. Write one or two sentences under each month's report noting what changed and why. Over a year, those notes become a useful history of your business and make planning far easier.

Year-end checklist

Before you rely on the annual P&L for your return, confirm every account is reconciled, personal items are removed, owner draws are not listed as expenses, and large purchases are recorded as assets where appropriate.

Reconcile, run it monthly, compare periods, watch margins, and remember that profit and cash are different numbers.