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A Beginners Guide To Profit And Loss Accounts – Getting Back To Basics.

As a business owner, there are a lot of things you need to focus on. And even when you’re settling down to just work on one area of the business, you will quickly discover that there are dozens of tasks, reports and other information you need to process and use. Finance and accounts are no different. One of the staples of good business accounting is the P&L, also known as the profit and loss account. Your P&L contains a goldmine of valuable information about how your business is performing and how it could improve in the future. But what exactly is a profit and loss account, and how can you use it to improve your business?

What A Profit And Loss Account WON’T Tell You

In its most simple form, a P&L will tell you how much you have sold (both as a total and broken down into individual products and services), how much you’ve bought and how much profit (or loss) you’ve made over a period of time. Each P&L report shows that performance over a specific period of time – be it a week, a month or a year. But it does have its limitations. For example, a P&L will not tell you:

  • The underlying health of the business (like how much it is owed, how much money it owes to debtors or what the value of its assets are)
  • Whether your business is generating cash. It will tell you if it’s generating profit, but that isn’t the same thing!
  • Any cash flow problems the business has. A business that’s profitable on paper can still experience cash flow problems, which is why it’s important for businesses to plan how their money is coming and going.

Used properly, a P&L can provide you with a detailed overview of the financial health of your business, allowing you to make informed decisions about the company’s future.

Varieties Of Profit And Loss Accounts

Just to add some more complexity, there are a few different ways that you can prepare a P&L for your business. For example, limited companies are required to send a set of accounts to Companies House every year, and these must be prepared in line with their rules. But many businesses will often put together a different P&L, which is used by managers and directors during strategy meetings to inform decisions. These tend to be put together in a different way, in a format that suits a more casual reader and highlights areas that management wants to focus on. While your statutory accounts need to cover a year, P&L’s can be adjusted to cover any time period management desire.

The Sections Of A Profit And Loss

Despite being used for different things and covering different time periods, P&L’s are all generally put together in the same way. There are usually 5 sections, although the detail in each section might vary from one business to another.

Turnover: Turnover is another word for your sales, and is the total value of what you’ve sold during the period covered by the P&L. If you wanted to, you could break this down into you different types of product, which can be helpful in determining which products are more popular or promoted better. Other kinds of income received by the business, like bank interest or money made from selling assets isn’t included in your turnover, since it doesn’t represent income from your main trading activity.

Cost of Sales: This is a breakdown of all the costs directly related to the sales you’ve made. So, if you’ve had to buy raw materials, stock to resell or the creation of stock in house if you’re selling products, or the cost of staff time if you’re selling services. No other costs are included in this section.

Gross Profit: This is the number calculated by taking the sum of your turnover and deducting the cost of your sales. It tells you how much profit you’re making directly from your sales.

Other Operating Costs: This is where all of those other costs go. The extra costs of running a business, like rent on premises, accountants fees, marketing costs – all the ancillary little things that aren’t directly helping sell products, and which wouldn’t really change if your sales figured went up or down significantly.

Net Profits: This is another formula: gross profit – operating costs. You could think of it as your ‘true’ profit, since it’s made up of all the income and all the costs. But don’t be fooled – this isn’t the profit you’ll pay tax on, since that’s calculated slightly differently. But it’s pretty close.

Of course, all of that might sound like double Dutch to you if finance isn’t really your thing. But that’s OK – that’s why you have us! At Accountwise it’s our job to help you navigate the murky waters of running a business and understand documents like this. Our experts are on hand to help you create accurate P&L reports, and to help you understand what to do with them too. If you would like to find out more about how Accountwise can help you improve your business through effective accounting, just get in touch with us today.