Profit and loss forecast: will your business earn enough to live on?

A revenue figure on its own says little. A workshop that turns over €180,000 can leave its owner a decent income or nothing at all, depending on what the bikes cost to buy, what the rent is and how much the loans cost. The profit and loss forecast, also called a projected income statement or operating budget, sets those lines against each other for the first three years. It tells you whether the business makes a profit, and whether that profit is enough to pay you and the bank.

This guide uses the worked example of Chainline Bike Workshop, which runs through all guides on business plan financials. Amounts are in euros and exclude VAT; the method works in any currency.

What a profit and loss forecast shows

The profit and loss forecast records revenue and costs in the period they belong to, whether or not money has changed hands. A bike sold in December is December revenue, even if the customer pays in January. That makes it the right tool for judging whether the business model works, and the wrong one for judging whether you can pay your bills next month. For that you need the cash flow forecast. Make the profit and loss forecast for three years, yearly, with year one also by month if your sales are seasonal.

The profit and loss forecast line by line

1. 01

   Revenue

   Sales excluding VAT or sales tax, per product group, taken from your sales forecast.

2. 02

   Cost of sales and gross margin

   What the goods or materials you sold cost you to buy. Revenue minus cost of sales is the gross margin: the money left to pay all other costs. Use the cost of what you sold, not of what you bought; stock on the shelf is not yet a cost.

3. 03

   Fixed costs

   Costs that run regardless of sales: rent, staff, marketing, insurance, vehicle costs, software, accountant, bank charges, telephone, repairs.

4. 04

   Depreciation

   The yearly share of your fixed assets, taken from your startup costs. The purchase itself never appears here.

5. 05

   Interest

   The interest on your loans, falling as you repay them. The repayments themselves are not a cost.

6. 06

   Profit before tax

   Gross margin minus fixed costs, depreciation and interest. Tax follows from this figure, and the rules depend on your country and legal structure.

What does and does not belong in it

Worked example: three years at Chainline Bike Workshop

Leo sells bikes at a margin of about 30% and does repairs at a margin of about 80%, because a repair is mostly his own time. In year two he hires a part-time mechanic.

Fictitious Firmfocus example. Amounts exclude VAT. Interest assumes 7% on the bank loan and 10% on the microloan, on the average balance per year, rounded to hundreds. The one-off start-up costs of €2,500 are shown separately in the startup costs; strictly, they lower year-one profit to €34,700.

Why profit dips in year two

Revenue rises by €40,000 in year two, yet profit falls by €4,100. Three things happen at once. The mechanic costs €22,000 from the first month, while the extra revenue builds up over the year. Most of the growth comes from bike sales: €30,000 of extra bike revenue adds €9,000 of margin, while €10,000 of extra repair revenue adds €8,000. That mix pulls the gross margin down from 46.7% to 45.9%. Lower interest saves €900, which softens the blow. In year three revenue grows by another €28,000 while the wage rises by only €2,000, and profit climbs to €44,400.

A dip like this is common when a business takes on its first employee. A lender will accept it if you explain it and if the cash flow shows you can get through it.

From profit to personal income

Profit is not the same as what you take home, and how the two connect depends on your legal structure.

Leo is a sole trader. His personal budget says he needs €30,000 a year, including a reserve for income tax and social contributions that his accountant has estimated. Loan repayments also have to be paid from what the business earns, while depreciation is added back because it costs no cash:

Fictitious Firmfocus example, simplified: stock, unpaid invoices and VAT timing are covered in the cash flow forecast.

For how much to pay yourself and when, see paying yourself; for the tax side of each structure, see choosing a legal structure.

Calibrating your costs against the industry

Your own forecast is a set of assumptions. Comparing them with businesses in the same sector shows which ones need a second look. Express each cost as a share of revenue: Leo's rent is 10.0% of revenue, marketing 2.2% and the gross margin 46.7%. Then compare with the industry figures, which give EU averages per sector for margins and cost structure, or run your figures through the profit and cost benchmark. A gross margin far above the sector needs an explanation; staff costs far below it usually mean a forgotten cost or an owner working unpaid hours.

Freelancer or business with staff

Where profit and loss forecasts go wrong

• Revenue without evidence: a round number with no volumes, prices or customers behind it.
• Forgotten cost lines: the accountant, software subscriptions, bank charges, card fees, repairs, bad debts.
• No income for yourself: a profit that looks healthy until you notice that you work full time for nothing.
• Underestimated staff costs: gross wages only, without employer contributions, holidays and the weeks spent recruiting.
• Margin at list price: no allowance for discounts, returns, theft or stock you write off.

The profit and loss forecast depends on the sales forecast and feeds the cash flow forecast. The overview of business plan financials shows how they connect, and Start a business has every guide for new founders.