Part 7 of 7 in the Smart Business Planning Series
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Using a profit and loss statement
In short, a profit and loss statement sets out the itemised details of sales and purchases that have been made by your business. It subtracts the total outgoings from the total income, to show you how much profit (or loss) you have made over a specific period of time. It’s often referred to as ‘the P&L’.
Why is a profit and loss statement useful?
Unlike a balance sheet, which shows a snapshot of your current financial situation at a point in time, a profit and loss statement shows how your company has performed over a specific period – a month, a quarter or a year.
It’s one of the most important financial documents you’ll need for running and growing a successful business. It lets you stay compliant – it helps you to submit accurate accounts at the end of the trading year – and it lets you understand the impact of purchases and sales on trading. In turn, this lets you expand your business, attract more investment, or recruit new members of staff to your team.
Does every business need a profit and loss statement?
If you’re running a limited company, then you’re obliged to produce a profit and loss statement every financial year. Your accountant will need the information to calculate your tax liabilities. Even if you’re working as a limited partnership, however, or as a sole trader, a P&L is still useful. As most P&Ls are produced in a standard format, it enables investors and suppliers to understand how your business is performing.
How do you create a P&L?
Most accountancy software has this function built-in. You can pull off a report detailing your P&L whenever you need the information. But it is still useful to understand the underlying approach to creating the final figure, be it positive or negative. The simplest formula is this one: ‘total revenue – total expenses = profit (or loss)’.
Details of your turnover form the basis of the P&L calculations. That’s the money earned from selling goods or services during a trading year. You will need to use:
sales receipts
sales invoices
credit notes and other sales documentation
Under normal accounting rules, sales and expenses are included in profit when they happen, not when they are actually paid. This means that profits include all credit sales and purchases made within the period, even if they haven’t been paid yet.
Gross profit is calculated by taking the sum of direct costs, things like materials and labour, and indirect costs away from sales made – usually over a 12-month period. Indirect costs are also known as overheads. You can see what your business’s gross profit margin is by dividing the gross profit by turnover, and the net profit margin by dividing its net profit by its turnover. This clarifies how much profit you’re making, overall.
In summary
The P&L is essential for calculating tax liabilities accurately, but also useful to help you compare the profit margins being made from one period to another.
For example, if the profit margins go up from one year to the next, this means that more of the income from sales is staying in the business – perhaps because you’re working more efficiently, putting up prices, or finding savings in your processes. Having a P&L to hand, on a monthly basis, helps you to focus on effective resourcing and the impact of purchases and sales on the overall health of your business.
Top takeaways
Tools and templates
Profit & Loss Statement - (Excel file download)
Disclaimer:
Please note that these guides are provided for information purposes only and not as advice or recommendations. Before deciding to undertake any course of action you may wish to seek independent professional advice.