Importance of Profit & Loss in Sole Proprietorship
Because a sole proprietorship is owned by a single individual, its financial health is inextricably linked to its owner's fiscal well being. Profit and loss in a small proprietorship can be an important indicator of whether that business can sustain itself fiscally. Although most sole proprietors develop strategies to access working capital even when their companies are losing money, no business can sustain itself indefinitely if it continues to operate at a loss. Because the ownership structure of a sole proprietorship is so narrow, its profit and loss is especially relevant to its capacity to continue operating.
A sole proprietorship's cash flow depends on how much capital the owner has available and how much money the business generates through ongoing sales. Profit and loss is calculated by subtracting the amount that the business spends from the revenue that it generates. For a sole proprietorship, owner income is synonymous with profit, so a sole proprietor who works long hours saves the expense of paying someone else to do the same work, and adds to the company's bottom line.
For income tax purposes, the profit or loss of a sole proprietorship qualifies as income or deductions for the individual who owns the business. Profit or loss from a sole proprietorship often leads to a higher tax burden than profit or loss from a corporate business structure, because sole proprietors are required to pay self-employment tax, or both the employer's and the employee's share of Social Security and Medicare taxes. Sole proprietors do have some discretion about when to make major business purchases for optimum tax advantages relative to their profit and loss statements.
A sole proprietor's ability to secure financing depends on his personal credit history as well as his company's financial track record. A financial institution making the decision of whether or not to lend money to a sole proprietorship will want to see that the business earns money and is capable of paying back the sums it borrows. A profit and loss statement is a concise way to show how much the business has earned, and how much discretionary cash it is likely to have available.
When a sole proprietor lists her company for sale, interested buyers will want to see that the business generates enough income to justify its sale price. A potential buyer will approach a profit and loss statement for a sole proprietorship differently from a profit and loss statement from a business with a corporate ownership structure because sole proprietor profit and loss statements treat owner salary as part of company profit. A sole proprietorship in which the owner does most of the work might earn considerably less if it paid an employee to perform the same tasks. This consideration might be grounds for a potential buyer to negotiate a lower sale price.