How to work out a profit and loss account

Your profit and loss account (also known as the income statement) is one of three key documents that show you the health of your company’s finances.

It gives you a clear picture of your revenue and expenditure over a set period, and it highlights areas where you’re excelling or struggling.

And if you’re analysing the long-term health of your company, it can be an important tool that helps you identify trends – for better or for worse.

What is a profit and loss account / income statement?

A profit and loss (P&L) account can be referred to by many names (including profit and loss statement, income statement and expense statement).

Essentially, it’s a financial statement that outlines the revenues, costs and expenses incurred over a certain period.

It’s most common to produce a P&L account on a quarterly basis and again at the end of the financial year.

Along with the balance sheet and cash flow statement, a P&L illustrates the strength of a company’s financial performance.

How does a profit and loss account work?

To produce your own profit and loss account, you’ll need to include a number of categories in your calculations. These include:

• Revenue (income generated from selling your products or services)
• Cost of goods/services sold
• Selling, general and administrative (also referred to as SG&A) expenses, which can cover everything from advertising and marketing costs to rent and travel costs
• Interest expenses
• Taxes
• Net income

To find out whether you’ve made a profit or a loss, you need to subtract the value of all your debts from all money that has been paid to you over the set period.

If the number is positive, you’ve made a profit. If it’s negative, your business has made a loss.

And of course, the greater the difference between the two figures, the better your profits or the worse your losses are.

Example profit and loss statement

Here is an example quarterly P&L statement to give you an idea of how it looks in practice. All figures are listed in GBP thousands.

We’ve consolidated the expenses into one row to make it easier to digest, but this would usually be split up into expense categories such as insurance, rent, advertising, salaries etc.

Why is a profit & loss account important?

Your P&L account will show you whether your company has made a profit (meaning you have generated more income than the sum of your expenses) or a loss (your expenses have been greater than your income) over the period in question.

But there are a number of ways to use it to analyse the financial health of your operations. You can:

• Identify areas that are boosting your profits and take action to ensure this continues in the long term
• Analyse the cause of a loss and trim costs accordingly (through measures such as finding a cheaper supplier)
• Analyse your performance year-on-year and identify key trends (both positive and negative) within your company’s performance
• Work out important margins, including gross and net profit margins, operating margin and EBITDA (earnings before interest, tax, depreciation and amortization) margin, and take action to improve them (either to boost returns or avoid future financial problems)
• Calculate rates of return, including return on equity (which you’ll also need the balance sheet for) and return on assets

How is a profit and loss account different from a balance sheet?

A P&L account will show you if your business is profitable overall and is a good way to judge its financial performance over a set period.

Whether you want to increase profit or reduce losses, or both, you can easily see how to make these changes based on the information in a P&L account.

A balance sheet will show you whether your assets are greater than your liabilities.

Rather than looking at customer demand, it shows you how effectively a company is using the resources it has to hand.

By adding all of its liabilities (money borrowed) and shareholders’ equity (money generated through investment), you can work out the value of a company’s assets.

If the balance sheet doesn’t balance – or the value of the assets is lower than the liabilities that must be paid – your company could quickly fall into insolvency if something isn’t done.

Another way of looking at it is to say that your P&L account tracks the health of your business over a period of time, whereas your balance sheet is a snapshot of a particular point in time.

So the two documents are useful together, but are not interchangeable.

Should I use an accountant to prepare my profit & loss account?

You can produce a profit and loss account on your own, but it’s a relatively complex process if you are not a trained accountant.

To do so, you’ll need to have kept your accounts very carefully throughout the year, or else the information you need to include may not be immediately obvious.

Enlisting the services of an accountant will allow you to concentrate on running your business while they crunch the numbers on your behalf.

It will also make sure you produce something that includes all the information you need to be fully compliant with HMRC and shareholder requirements.

Do all small businesses need to file P&L statements with HMRC?

All limited companies need to file their statutory accounts with HMRC (which include a balance sheet, profit and loss account and a director’s report) as part of the financial year end reporting.

This process ensures you’re paying the right amount of tax and that shareholders and potential investors can get a clear picture of the financial health of your company.

If your company is considered ‘small’ (a turnover of £10.2 million or less, has £5.1 million or less on its balance sheet or fewer than 50 employees), you don’t have to send your P&L account to Companies House.

A micro-entity (a turnover of £632,000 or less, has £316,000 or less on its balance sheet or fewer than 10 employees) also isn’t required to submit a detailed P&L account.

It will only need to meet statutory minimum requirements for year-end reporting.