Profit and Loss Statement Looks Wrong? What to Check, in Order

Why doesn't my profit match my bank account?

A profit and loss statement (P&L) can add up correctly and still not match the bank, because profit and cash are different things. Some cash moves are not income or expenses: a loan received or repaid, money you put in or took out, sales tax you collected for the state, equipment you bought (generally depreciated), inventory you have not sold. Timing also splits them: a December sale paid in January, a bill not yet paid. A P&L that looks wrong is often correct arithmetic on mislabeled or missing transactions.

A one-time clean-up may be enough when one business, one period and one set of accounts is involved and nothing has been filed or sent to a lender on the wrong numbers. Treat it as a case for professional judgment if any of these is true:

• The wrong profit is already on a filed return or in a loan or sale package.
• A lender, buyer or CPA is waiting and you cannot say which account or period is wrong.
• The books are months behind, or personal and business money share an account.
• The business holds inventory, runs payroll or has several entities.

Gather first: bank and card statements for the period, payment-processor reports, loan statements, payroll reports, the last filed return and inventory counts. Publication 583 lists the supporting documents that back up the books.

In what order do I check it, and what do I hand a bookkeeper or CPA?

Check in this order, because each step makes the next one trustworthy. Re-run the P&L after each step to see which fix moved the profit.

Hand over the statements above, the P&L with the basis it was run on (cash or accrual), and a short list of what you found and changed.

Are my accounts reconciled, and is anything left uncategorized?

An account is reconciled when the books' ending balance agrees with the statement after allowing for items that have not cleared. Publication 583 says to reconcile the business checking account each month: it confirms the balance, picks up bank charges and corrects errors in the statement, checkbook and books. Do the same for every card and loan account. Imported bank transactions still need this check (see bank feeds are not reconciliation).

Look for a balance that disagrees with the statement, a month with no statement, and anything parked in an uncategorized or holding account (a place for transactions no one has labeled). Check the account's type: one on the P&L already counts in profit under the wrong label, and one on the balance sheet is not in profit at all. If a closed month's opening balance has changed, see reconciliation beginning balance wrong.

Also look for the same money counted twice. A payment from the bank to the business's own credit card, or a transfer to savings, moves money between accounts and is not an expense; the expense is the charge on the card. See credit card payments in the books.

What accounting method is my bookkeeper using, cash or accrual?

Cash counts income when received and expenses when paid. Accrual counts them when earned and incurred (Publication 334). A December sale paid in January, or a December bill paid in January, lands in different periods under each.

Ask which basis the P&L is run on, then compare it with the method on the last filed return (Schedule C, line F, for a sole proprietor). Publication 334 says to use the same accounting method to figure taxable income and to keep your books. The Form 1065 instructions say a partnership's method must be reconcilable with its books and records, and the Form 1120-S instructions say to figure income by the method regularly used in keeping the corporation's books. If the two differ, find out why before changing either; see accrual books and a cash-basis tax return.

The books and the return can differ even on the same method, because the return applies tax rules the books do not, such as limits on travel and entertainment. The Form 1065, Form 1120 and Form 1120-S instructions each include a schedule that reconciles income per books with income per return (Schedule M-1, or Schedule M-3 for larger entities). A difference alone does not mean the P&L is wrong; one no one can explain is a question for a CPA.

Some businesses cannot use cash. A C corporation, or a partnership with a C corporation as a partner, generally cannot unless an exception applies. A tax shelter, which includes a syndicate (an entity with more than 35% of its losses going to owners who do not actively manage it), may never use cash (Form 1065 and Form 1120 instructions). A business with inventory generally uses accrual for sales and purchases unless it is a small business taxpayer (Publication 538; Schedule C instructions; Form 1120-S instructions). Changing method generally needs IRS consent on Form 3115 (Publication 538); see switching from cash to accrual accounting for who qualifies.

Are loan deposits or money I put in counted as sales?

Neither a loan deposit nor money you put into the business is income. Money borrowed through a bona fide loan is not income (Publication 334), and Publication 583 suggests recording the source of each deposit as business income, personal funds or a loan. A transfer between the business's own accounts is none of these.

List every deposit not tied to a customer, an invoice or a processor payout: round amounts, a lender's name, the owner's name, transfers from savings. Record a loan as a debt (see recording a business loan). Money the owner put in is a contribution or a loan from the owner, depending on what was agreed and documented (see owner contribution or loan to your LLC); if that is unclear, it is a question for a CPA.

Interest on a debt used for the business is generally an expense, subject to limits (Publication 334). Repaying the principal is not an expense; it reduces the debt.

Is sales tax I collected counted as income?

Whether sales tax you collected counts as income depends on who the law taxes. Sales tax imposed on the buyer, which the seller must collect and pay over, is not income (Publication 334) and is not a deductible expense (Schedule C instructions). If the tax is imposed on the seller and collected from the buyer, the amount collected is part of gross receipts and the tax is deducted as a tax expense (Publication 334; Schedule C instructions, line 23). Which case applies depends on how the state's law words the tax, so confirm it with the state tax agency. If the state lets a seller keep part of the tax collected, that part is income on Schedule C, line 6 (Schedule C instructions).

If the tax is the buyer's, check that the sales line excludes it and that the sales tax payable balance matches what was filed. If it is the seller's, check that receipts include it and that a tax expense is recorded. See sales tax journal entries and sales tax payable does not match the return.

Are owner draws, personal spending or equipment sitting in expenses?

Owner draws, personal bills and equipment purchases are not ordinary expenses. The Schedule C instructions exclude business equipment or furniture, replacements or permanent improvements, and personal, living and family expenses from other expenses.

In an S corporation, payments to an officer must be treated as wages to the extent they are reasonable pay for services (Form 1120-S instructions). See recording owner's draws and, for an S corporation, S corporation paying personal expenses.

Property expected to last more than a year generally is depreciated, not deducted in full when bought (Publication 334). Three tax rules can still put the full cost in the first year: the de minimis safe harbor election for small purchases (Schedule C instructions), the section 179 election, and bonus depreciation, which applies to qualifying property unless the business elects out (Publication 946). Before moving an item, check the asset list, the books' policy and the filed return; see expensing or capitalizing small purchases and writing off equipment in the first year. Personal bills paid from the business account are not deductible, but they still belong in the records (Publication 583); see fixing commingled business and personal funds.

Are payouts, fees and refunds counted twice or only net?

A payout can differ from the sales behind it. Recording only the deposit understates both sales and expenses by the fees taken out. Recording the invoice as income and then the deposit as income counts the sale twice.

The books should show gross sales as sales, fees as an expense and refunds as returns and allowances, which Publication 334 describes as cash or credit refunds to customers, rebates and other allowances off the sales price (reported on Schedule C, line 2).

Form 1099-K reports the gross amount without regard to fees, refunds or shipping (instructions), so neither it nor the payout is automatically your sales figure. Tax the processor withheld from payouts (backup withholding, reported in box 4) is tax withheld for you, not a fee. Matching them is covered in reconciling sales and payouts.

Cash that never reaches the bank has the same effect. If the business takes cash and pays some costs from the till before depositing, the deposits understate both sales and expenses. Publication 583 says to deposit all daily receipts in the business account and shows a daily summary of cash sales taken from the register tape or sale slips; see cash business sales records.

Are cost of goods and inventory right?

For a retail or wholesale business, divide gross profit by net receipts (gross receipts less returns and allowances) and compare the result with the pricing policy. Little difference suggests gross profit is accurate; a large difference may show that sales, purchases, inventory or other costs were not figured accurately (Publication 334). A business that sells only services skips this test.

Compare gross profit as a share of sales, not markup on cost. The same price gives a smaller percentage on sales than on cost.

If the test fails, check that beginning inventory usually matches last year's ending inventory, that purchases exclude goods taken for personal use, and that ending inventory comes from a documented count (all from Publication 334). A small business taxpayer may choose not to keep an inventory; see inventory or supplies for small sellers.

What is usually missing that moves profit?

Four entries can be absent from a P&L built mostly from bank activity. Each raises profit when it is missing, except unpaid bills, which matter only on the accrual basis; on the cash basis a bill is an expense when paid.

What if the wrong profit is already on a filed return or in a loan package?

Correcting the books does not correct what has been filed or sent. The return and the lender's file each need their own fix.

For a filed individual return, the IRS says you may need to amend after finding an error, and Form 1040-X corrects a previously filed Form 1040. A refund claim on it generally must be filed within 3 years after filing the original return or 2 years after paying the tax, whichever is later (Form 1040-X instructions). For a partnership or corporation, see correcting a filed business return.

Editing a closed year alters balances already filed or reported (see closing date after taxes are filed). A lender or buyer holds the old numbers, so keep the old P&L, date each correction and list what changed (see proving income to a lender).

Example

These examples are illustrative; all amounts are in US dollars.

Draws and a loan in the wrong places

A plumbing LLC taxed as a partnership shows a $5,000 loss on its P&L. The owners' draws of $30,000 were booked as expenses, and a $25,000 loan deposit sits in sales. Taking out the draws adds $30,000 to profit. Taking the loan out of sales subtracts $25,000. The $5,000 loss becomes $0 profit, and the loan appears as a debt.

Fees netted from payouts

An online seller's P&L shows $140,000 of sales, but the payment processor's Form 1099-K reports $168,000. Suppose the whole $28,000 difference is fees taken out of payouts. The books should show sales of $168,000 and fees of $28,000 as an expense. Profit does not change, but the sales line now ties to the form. If part of the gap were refunds or sales tax, each is treated as described above.

Gross profit far from the pricing policy

A retail shop has net receipts of $200,000 and cost of goods sold of $120,000, so gross profit is $80,000, or 40% of net receipts. Its pricing policy targets 55%, which would be $110,000. The $30,000 gap points to sales not recorded, purchases that include items that are not inventory or are entered twice, an ending inventory counted too low, or a policy that no longer matches real selling prices.

Different for you?

• A lender, buyer or CPA is waiting and you cannot say which account is wrong: a one-time clean-up and a rebuild from bank records are different jobs (see rebuilding books from bank statements). Which one the books need, and what happens to a return already filed, is the question to settle with bookkeeping help. For a lender, also see proving income to a lender.
• The wrong profit is already on a filed return: see correcting a filed business return.
• The books are months or a year behind: see catching up on overdue books and bookkeeping help.
• The balance sheet looks wrong too: loan, equity and payable balances that will not clear often share a cause with the P&L; see small business balance sheet looks wrong.
• Payouts, fees and Form 1099-K do not tie: follow reconciling sales and payouts.
• Personal and business money share accounts: see fixing commingled business and personal funds.
• You are deciding whether to keep doing this yourself: see doing your own books or hiring a bookkeeper and the month-end close checklist.