Following on from last week’s article about An Unreasonable Expectation, I thought I’d explain some of the basics of the Accountancy world, to help demystify what we get up to! I’m going to start with ‘Understanding your Profit & Loss account’.
What is a Profit & Loss Account?
Firstly, it has many different names! These include:
- Profit & Loss Statement
- Profit & Loss Sheet
- Income and Expense Account
They all mean the same thing! A Profit & Loss Account is a summary of the revenue and costs within a business in a period. It could be over a month, or a quarter, but for many businesses is most often seen over a year as part of the end of year accounts.
The result of a Profit and Loss will be either:
- A Profit – where income exceeds the expenses or
- A Loss – where expenses are higher than the income received.
The end result is arrived at by taking the costs and expenses of the businesses from the income over the same period.
Why do I need a Profit & Loss Account?
All Limited Companies are required by law to produce a Profit & Loss Account, which feeds into the Corporation Tax Return to calculate the Company’s Corporation Tax liability.
If you aren’t trading as a Limited Company, you will effectively produce a Profit & Loss to create your sole trade accounts. This will feed into your Self Assessment Tax Return and tell you how much tax you have to pay.
The biggest reason to monitor your Profit & Loss account though is to see how the business is performing!
From the Profit & Loss you can show investors, shareholders, managers or lenders that you are making money. It will also show you if adjustments might be needed, for example if expenses are too high.
How can I get a Profit & Loss for my Business?
There is an accepted format for a Profit and Loss Account, which most software can create for you fairly simply.
In its simplest form, a Profit & Loss starts with Gross Income. This is the total of all your sales or revenue in the period. From that you will deduct Direct Expenses, the resulting figure is known as Gross Profit. These are the costs directly attributable to proceeding your goods or services, so raw materials, shipping costs and labour would be examples.
Operating Expenses or Overheads come off next. These include expenses that aren’t directly attributable to the creation of your product, and can be defined as being unaffected by volume of sales in many cases. Examples here would be rent, light, heat, marketing, accountancy fees, as well as any salaries that aren’t directly related to sales.
All of these figures should be excluding VAT.
The end result, in it’s most basic form, is your Profit or Loss for the period.
There are many adjustments and tweaks that would be added to the calculation, but hopefully that gives you an idea of what a Profit & Loss Account is, and why it can be so valuable to a business owner.
In Part 2 we’ll look at the four most important numbers that are included in your Profit & Loss, and what they can show you.
If we can help you understand more about your accounts, or your business numbers please do get in touch. They do NOT have to be intimidating, and understanding them can make a huge difference, both to your confidence and to your Profits (or Losses…!).