How Do You Read a Profit and Loss Account?

Profit Or Loss Keys Showing Returns For Internet Business

Along with the balance sheet, your Profit and Loss account (sometimes known as an Income and Expenditure account) is one of the key elements that your accounting software (or your accountant, if you have one) will produce for you. But what is a Profit and Loss account, how do you read it, and what can you do with the information within it?

According to the Collins dictionary, a P&L account is a an account that is compiled at the end of a financial year, showing that year’s revenue and expense items and indicating gross and net profit or loss.

Whereas a Balance Sheet provides a snapshot of your business’ financial position at just one moment, the Profit and Loss account covers a period of time. While most businesses produce a Profit and Loss account every year, it doesn’t have to be an annual event only. In fact, you can produce a Profit and Loss account as often as you want, to cover any period of time. You could produce one weekly, monthly, quarterly or annually – however often you need to within your business.

Some key points about the Profit and Loss account:

  1. What is a Profit and Loss account?

The Profit and Loss account is a reflection of the revenue generated and expenditure activity associated within one period. You may deliver work in this period but not get paid until the next. You may receive goods and not pay until later. The Profit and Loss records the activity during the specific period, regardless of whether or not you actually receive or pay the money at the time.

Look at your Profit and Loss account as often as you can. If you leave it too long you may find it’s too late to be of any use.

Don’t look at your Profit and Loss account in isolation. Make sure you also keep an eye on the Balance Sheet as that can be where ‘surprises’ may lie.

  1. How can I show my profit?

Profit and Loss sheets come in different formats. The layout, categories, sub-categories, details, levels of costs and income matching you what you choose for your business is up to you and your accountant. Use a format that you can understand and that allows you to correctly interpret the information.

When deciding on the format for your Profit and Loss account, think about what you want to do with it and how you will read it. Design it with that purpose in mind. For example, you might specifically want to use your Profit and Loss sheets to help you calculate breakeven sales or look for exceptions, both good and bad. Make sure you design it with the information you need to do that.

Don’t include more detail than you need. Pick out the key elements that work for you; otherwise you’ll end up with paralysis by analysis!

  1. Can I show less profit?

If you are a limited company think carefully about where you put your Directors’ drawings or dividends. When you report to HMRC, these figures will not be on the Profit and Loss sheet, even though they are a real cost within your day to day management.

Overheads, or fixed costs, are those that happen regardless of whether your business makes a sale (for example rental of business premises or staffing.) Make sure any overheads you include are relevant to the period that the Profit and Loss account covers. For example, an insurance invoice received and paid in January may cover the whole year, so work out the monthly or quarterly costs to apply to your report.

It can be tempting to manage your profit and loss statement and accounts to reduce the profit on which tax will be due – however, be cautious with that – there may come a time when you want to borrow money or sell the business – you don’t want to show a weakened statement then!

Be aware that if you look at someone else’s Profit and Loss sheet, they may have adjusted it within the boundaries described to make it say what they want you to read!

  1. How else can I use my Profit and Loss account?

If you’re looking for investment in your business, or you want to sell it and need to have your business valued, you will need to show your Profit and Loss account to other people.

The cost of sales – both direct costs and variable costs – should be those that are directly attributable to the sales that you have reported within the time period of the profit and loss account.

Gross profit (sales less variable costs) is the profit that you have made to cover the fixed costs.

The real value of Profit and Loss accounts is that you can use them to compare the performance of your business in any period with the same period in previous years, or to help you plan a budget for next year.

If you don’t currently produce a regular Profit and Loss account, or you’d like to understand more about the role it could play in helping you understand your finances and grow your business, give us a call on 01993 77 11 00 or email Graham@MakingSenseOfNumbers.co.uk.

www.MakingSenseOfNumbers.co.uk

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