A profit and loss statement (also known as an income statement) is a financial report that shows your revenue, expenses and earnings for a specific time period, typically a fiscal quarter or year.
Simply…
Profit = Revenue – Expenses
A profit and loss (P&L) statement starts with an entry for revenue (the top line), then subtracts expenditure, such as cost of goods sold, operating expenses and non-operating expenses. The difference between the two (the bottom line) is your net income.
This statement can be used to track business performance over time and consequently influence your decisions for the future.
All limited companies must produce a P&L account (and a balance sheet) to submit to Companies House, as part of their year-end reporting. Since October 2023, the Economic Crime and Corporate Transparency Act means small businesses and micro-entities must also file a P&L account.
If you are starting a new business and require funding, you will need to produce a proforma P&L that forecasts your future finances.
This article will cover how to set out a P&L statement, as well as exploring what this information can tell you…
1. Net revenue
Revenue is the income generated by your business from its activities, including sales of goods/services, as well as interest and investment income.
If your business has diverse sources or income, your P&L statements might separate each stream, then combine them for overall revenue. This can give a more detailed perspective on the performance of each business activity.
Gross revenue (total revenue), is the entire amount you make before accounting for discounts, returns, or allowances.
Net revenue is the money you make after deducting discounts, returns and allowances from your gross revenue.
2. Gross profit
Expenses are the costs incurred by your business to generate revenue.
Cost of goods sold (COGS) is the direct expense of materials and labour a business needs to produce its product or service. This can range from the cost of raw materials to transporting goods. COGS appear on the top part of the P&L before gross profit.
Employee payroll is a bit of a grey area. Salaries for factory workers might constitute COGs, whilst wages for administrative staff could be considered an operating expense (see below).
3. Operating income
Unlike COGS, operating expenses are the costs of running a business day-to-day (indirect to producing the product/service), such as rent, utilities and research and development. Salaries for administrative staff, not directly involved with delivering the product/service, could be included (see above).
Income is how much money a business makes. There are two key types of income – operating and net income.
Operating income demonstrates how effectively a business generates money from its core operations, excluding non-operating expenses (see below).
4. Net income
Non-operating expenses are costs that are not part of your core operations such as taxes, interest and legal fees. Other non-operating expenses might be one-off events such as losses from disposing of an asset.
Net income is the last item (the bottom line) on your P&L statement, coming after what you have calculated for both your operating and non-operating expenses. This shows what money is left for shareholders or owners.
Your P&L statement might be set out like this…
Uses for your P&L statement
Knowing how to read a profit and loss statement is vital for making informed decisions.
- Identify areas that are boosting your profits.
- Find any areas that are not profitable. Take action to remedy this or reduce the influence of these activities.
- Assess your current P&L statement with previous periods, to identify performance trends.
- Compare your P&L statement to your budget to see if you are meeting, surpassing, or falling short of expectations.
- Set future targets from the current performance of your P&L statement.
- Alongside your balance sheet, calculate rates and ratios for a more insightful perspective on your finances.
Cash or accrual accounting
Something that will affect the contents of your P&L statement is whether you use the cash or accrual accounting method.
The cash accounting method measures when cash actually goes in or out of the business. Therefore, a business records transactions as revenue whenever cash is received and as liabilities whenever cash is used to pay any costs. This approach tends to be used by smaller business and sole-traders.
The accrual method records revenue as it is earned/spent regardless of whether the transaction has actually taken place. Therefore, money expected to be paid to and by the business in the future is already accounted for.
What’s the difference between a P&L statement and a balance sheet?
A balance sheet is more detailed, containing greater information on assets, liabilities and working capital. It offers a snapshot of a business’s finances at a certain point in time (typically at year-end). This can allow outside parties, such as investors or Companies House to assess the financial position of the business.
In contrast, P&L statements are more useful for analysing profits and losses over a period, shaping business strategy by identifying trends.
Therefore, the two documents can be used effectively together, but are not interchangeable.
Get some insight…
Many business owners or senior staff don’t think about the P&L statement until it’s time to file for taxes. This can mean they struggle to put the document together and aren’t certain what the numbers mean.
P&L statements are best reviewed regularly, keeping your finger on the pulse of your business. This will mean you can adjust your strategy accordingly with better insight on what’s really making/costing you money. You may opt to produce these statements more frequently to get ahead of the game.
If you require assistance with producing, interpreting and taking action from your business’s P&L statements, please contact us and member of our team will be happy to assist you.
