The Profit & Loss (P&L) Statement

Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship)

Linked here is an example of a company’s P&L for a certain year. As a business owner or self-employed individual, you NEED TO KNOW what a P&L looks like and how to read one. The P&L is the actual document used to prepare your tax return, whether you file a Schedule C, E, or F (Form 1040), a Form 1065, or any of the Form 1120 variations.

Bookkeepers are responsible for creating financial statements such as a P&L for a business. But for simple businesses and side gigs, all you need to do is familiarize yourself with the terms below, add up all your revenue, add up all your expenses, and do the math to find out your profit. Don't forget that most business expenses are tax deductible. Don't pay income tax on money you no longer have! For tax season, you should be assebling the draft P&L for your business activities together in December and have the final P&L ready for tax season in January. Procrastinating on the P&L is the number one reason that business owners get hit with late penalties and interest, which I have summarized below to properly motivate those who need it. I recommend Quickbooks Online for bookkeeping regardless of whether you hire a professional bookkeeper or not.

Go to the Securities & Exchange Commission’s (SEC) Electronic Data Gathering, Analysis, and Retrieval (EDGAR) website and search for the financial statements for any publicly traded corporation that interests you. Specifically, look for the company’s most recent Form 10-K (annual earnings) and/or Form 10-Q (quarterly earnings) reports. You will be able to see the financial statements for massive businesses. They mostly follow the same principles of accounting your business follows. Sometimes they will break their financial statements into pieces to allow for more detail. Regardless, they are very important to understand, especially if you are investing in a company’s stock, or if an investor or lender is considering doing business with your company. You are a businessperson. This is business. Learn and enjoy!

Terms and Notes:

• Gross Receipts = Gross Revenue + Other Income

• Other Income/Expenses are transactions that occur outside of the core business activity.

• Gross Profit = Gross Margin

• Revenue may be subcategorized into Sales, Services, and even more specific accounts, if desired, such as by project.

• Income taxes and Estimated Taxes are not listed on the P&L because they are personal expenses of the business owner (Exception: C corporations pay a flat 21% corporate tax on earnings).

• COGS is the direct costs to acquire or produce finished products or merchandise for resale (such as inventory). Not every business will have COGS, especially service-based businesses.

• EBIT = Earnings Before Income Taxes (seen on P&Ls of large corporations)

• EBITDA = Earnings Before Income Taxes, Depreciation, and Amortization (seen on P&Ls of large corporations)

• Profit & Loss Statement = Income Statement

• The opposite of Profit or Earnings is Loss

Methods of Accounting

All financial transactions are broken down into six categories. Each category might have several subcategories (collectively, the “chart of accounts”) that keeps track of money and wealth as it flows through a company. My company uses double-entry accounting and only works with bookkeepers who understand and use double-entry accounting. You don’t need to memorize “Debit” or “Credit,” but they represent the two-sides to every transaction. If you have a partnership or a corporation with more than $250,000 in gross receipts or $250,000 in assets, you need to know the accounting equation because now you need to understand a second type of financial statement: the balance sheet.

Derivation of Accounting Equation:

Assets = Liabilities + Equity

Assets = Liabilities + Equity - Dividends + Net Profit

Assets = Liabilities + Equity – Dividends + Revenue – Expenses

Dividends + Expenses + Assets = Liabilities + Equity + Revenue

“DEALER”

Debits Increase DEA Accounts Debits Decrease LER Accounts

Credits Decrease DEA Accounts Credits Increase LER Accounts

Calculation of Taxes

1. In the linked P&L, if this was a self-employed business, there would first be an assessment of self-employment tax of 15.3% on the self-employment earnings, or Net Income.

   
   

2. $82,852 * 0.153 = $12,676 Self-Employment (SE) Tax

   
   

3. Then the $82,852 would be reduced by ½ of the SE tax to bring it more in line with what a W-2 employee’s wages would pay in taxes.

   
   

4. $82,852 - $12,676/2 = $76,514, which would be added to Adjusted Gross Income (AGI).

   
   

5. After taking the MFJ standard deduction of $29,200 (2024) and assuming no other income:

   
   

   1. $76,514 - $29,200 = $47,314 Taxable Income

      
      

   2. The $47,314 would be filtered up through the MFJ (in this example) marginal tax brackets and end up owing $5,238 in Tax.

      
      

   3. Tax of $5,238 + SE Tax $12,676 = Total Tax of $17,914.

      
      

6. The IRS would add up your withholding and estimated tax payments and subtract your Total Tax to come up with your balance due or refund.

   
   

7.  If a balance due is not paid in-full by April 15th, then the IRS will start adding Failure-to-Pay penalties and interest to your balance due, compounded daily.

   
   

   1. IRC §6651(a)(1) Failure-to-File Penalty – is equal to 5% per month, or part of a month, of any unpaid balance due on an return not filed by its due date or extended due date. Can accumulate up to a maximum of 25% of unpaid balance.

      
      

   2. IRC §6651(a)(2) Failure-to-Pay Penalty – is equal to 0.5% per month, or part of month, of any unpaid balance after the return’s due date. Can accumulate up to a maximum of 25% of unpaid balance.

      
      

      1. IRC §6651(h) Reduced to 0.25% per month, or part of month, of any unpaid balance during any month in which a valid Installment Agreement is in effect.

         
         

      2. IRC §6651(d)(2) Increased to 1.0% per month, or any part of month, of any unpaid balance 10 days after a Notice of Intent to Levy (Notice CP504) is issued.

         
         

      3. IRC §6651(c)(1) In any month where a Failure-to-File penalty and a Failure-to-Pay penalty both apply, then the Failure-to-File penalty is reduced by the Failure-to-Pay penalty before being added together. This results in a maximum combined penalty of 47.5% of unpaid balance.

         
         

   3. IRC §6601 Interest – is added to the balance of any unpaid tax, penalties, or interest, compounded daily, at a rate equal to the Federal short-term rate plus 3%, rounded to the nearest whole number, and determined quarterly (IRC §6621).

      
      

   4. IRC §6654 Estimated Tax penalty – calculated by applying the interest rate from §6621 to the amount of underpayment for the period of time the underpayment exists, until original tax return due date. There will be a separate blog post on estimated tax payments.

The P&L statement is crucial component to calculating income tax resulting from business activities.