Profit and Loss Accounts

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.

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How to calculate trading, profit and loss accounts

There are a number of key formulae to bear in mind when calculating profit and loss accounts:

  • Gross profit = total revenue – COGS
  • Net operating profit = gross profit – OPEX
  • Net profit before taxes = net operating profit + other income – other expenses
  • Net profit or loss = net profit before taxes – income taxes

How to do a trading, profit and loss account statement

Items you need

  • Banking transactions: your banking records should include listings of all transactions relating to your business bank accounts and purchases.
  • Cash transactions: all receipts related to cash purchases for your business, including petty cash transactions.
  • List of income sources: including cash, cheque, credit and online payments made to your business.

How to prepare a profit and loss statement: rough profit and loss account example

The basic steps to preparing a profit and loss statement are:

  • Show your net income (sales) generated by the business
  • Itemise your expenses for the reporting period as a percentage of your net income (sales)
  • Calculate your Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA) and calculate the difference between your sales and expenses as earnings
  • Account for interest payments by subtracting your annual business debt from your EBITDA
  • List your taxes against your net income, and subtract them from your revenue
  • Calculate total depreciation and amortisation and subtract that from your revenue.

Do all of the above accurately and you will be left with your net earnings figure, which is the profit or loss your business has taken on for the period. All being well, you should see a profitable number. You can find more detail on profit and loss account formats and how to prepare statements via FreshBooks.

Is it time to take your business to the next level?

With the profit and loss account explained, you’ll understand its importance to your business, particularly when it comes to accessing additional finance. At Nucleus, we look to combine a traditional credit facility base with the speed, efficiency and transparency of contemporary alternative lending.

If you’d like to see what sort of finance your business can access, contact us today. But first, make sure your P&L is in order!

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