Profit and Loss Accounts

With the goal of business always being to make a profit, knowing where you stand with regard to your financials is key to running a successful organisation. Therefore, the value of running an efficient, detailed and accurate trading, profit and loss account cannot be overstated.

A profit and loss account will do exactly what it says on the tin, enabling you to understand the most important numbers behind your business operation and, crucially, whether you are indeed making a profit. Alongside the balance sheet, it makes up one of the two most important statements in business accounting.

An unquestioned essential for smart business management, and a key requirement for tax matters and loan applications, establishing a proper trading, profit and loss account should be one of your first ports of call as a business. Here, we’ll answer a number of key trading, profit and loss account questions, including the purpose of a trading, profit and loss account in accounting, what it shows and how to do your profit and loss account correctly and effectively.

What is a profit and loss account?

A profit and loss account, sometimes known as an income statement or statement of operations, is a financial report that summarises the total revenue and total expenses of a business across a given period of time.

The basic formula behind a profit and loss account is:

• revenue – expenses = profit

A profit and loss statement contains summarised information of a business’ credits with deductions made up of elements including overheads, cost of sales and allowances, ultimately providing the business with a figure that indicates whether it’s in net profit or net loss. Statements are typically generated on a weekly, monthly, quarterly or annual basis.

The goal of a trading, profit and loss account is to calculate accurate profit/loss and give an overview of the wider financial health of the business.

What does a profit and loss account show?

There are multiple components of a profit and loss account. The six key profit and loss account items are:

1. Revenue: the turnover of the business during the accounting period, including all revenue streams from primary business activity, non-operating revenue, and gains from long term business assets.
2. Cost of goods sold (COGS): the direct costs of producing the goods sold by the business, including material costs and labour costs.
3. Gross profit (or gross income/gross margin): calculated by deducting the COGS from total revenue.
4. Operating expenses (OPEX): the expenses a business incurs through its normal operations, including rent, equipment, inventory, payroll, insurance, marketing, step costs and R&D costs.
5. Operating income: the amount of profit generated from business operations, calculated by deducting OPEX from gross profit.
6. Net profit: the total profit amount remaining after deducting all expenses.

Why is a profit and loss account useful?

Why do we prepare profit and loss accounts? Well, P&L reports have a number of administrative commercial and regulatory uses to them, even beyond the information provided on net profit.

Of course, net profit data is the primary purpose of trading, profit and loss accounts, and can be used by business owners and accountants to make key decisions on cost-cutting and incorporate new methods of driving revenue. P&L reports also offer a business a number of key details around cash flow, spending trends, net income and the wider profitability of the business, all of which can contribute to important budgetary decisions, too.

There are also multiple uses of trading, profit and loss accounts from a regulatory and administrative standpoint. If a business decides to apply for a loan such as asset finance, then an accurate profit and loss statement will be required. P&L reports also help businesses to calculate income and corporation taxes which, if filed incorrectly, can lead to huge penalties and fines. Thus, it’s essential that a business’ profit and loss account is correct.