A profit and loss statement is a report which shows how much money a business has both earned and spent over a certain period of time.
If the company has spent more money than it has made in the given timeframe, then it has made a net loss. On the other hand, if revenues were higher than the costs, then a profit has been made. This is otherwise known as a net income. This is why the statement is called a profit and loss account.
How a P&L Statement Works
A profit and loss statement is split into several categories, highlighting the net income/loss at various stages before or after certain deductions.
First of all, there is the overall revenue, which is the total amount of money earned from selling all the products and/or services provided by the business.
Below this would be the cost of any returns & refunds on products and services. This should be a very small amount; a high value indicates poor quality control and should be an area of focus for cutting costs. The total net revenue can then be calculated by subtracting this cost from the overall revenue.
There will be a section for the costs of goods/services sold. Subtracting this from the net revenue will result in a number for gross profit. Gross profit will most likely be the next row on the profit and loss statement.
Depending on the nature of the business, expenses may be the largest cost in the P&L sheet. Expenses include rent, travel, salaries and marketing costs among others. By further splitting the expenses into individual sections, the business will be able to pinpoint which costs can be cut in order to improve profits.
Finance costs are a separate line on the profit and loss statement. It refers to any extra expense generated by interest rates on money that has been borrowed and not been paid back. Again, this should be a relatively small number compared to the rest of the costs.
The final cost on the P+L will be tax. Corporation tax for limited companies in the UK currently stands at 19%.
Finally, net profit, whether that be a profit or loss, is found at the bottom of the statement. It is calculated by subtracting expenses, interest and taxes from the gross profit amount.
Here is an example of a profit and loss statement:
|Returns & refunds
|Total net revenue
|Cost of goods sold
|Earnings before interest & taxes
|Earnings before taxes
In the above example, the expenses have not been split into separate categories. There can be many different forms of expense, making the profit and loss statement quite cumbersome and difficult to understand. Here at PPS Chartered Accountants, our team can create P&L accounts modified for your business.
The Importance of a P&L Statement
Immediately upon creation of a profit and loss statement, you should be able to identify areas of either revenue or cost which need thorough analysis.
If your profits are looking healthy for the time period, you can identify key areas of revenue which are improving income and ensure that these sources are maintained in the long run.
Conversely, you may notice some cost areas which are causing your margins to fall too low. It may be required to cut these costs entirely or look for a cheaper alternative.
Take a look at multiple consecutive P&L statements. In the long-term, you may notice a trend in your profits. They could be steadily increasing or decreasing over time. Changes may need to be made to the business’ financials to reverse a downward trend in profits.
A profit and loss statement is very useful for calculating various earnings for your business, whether that be gross or net profits, or the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation). The last one is especially useful for quantifying the financial performance of a business. Once you have a better understanding of your profit margins, you can take a more examined approach in trying to improve them.