A Guide to the Profit and Loss Account

A Guide to the Profit and Loss Account

Along with the Balance Sheet and Cash Flow Statement, the Profit and Loss Account forms the basis of every company’s accounts, providing a snapshot of your incomings and outgoings over time. While most UK-based Limited Companies must produce a Profit and Loss Account every financial year to submit to HMRC, it is also a useful process for self-employed sole traders and those in a partnership as it helps to provide a clear picture of how a business is performing.

What is a Profit and Loss Account?

The Profit and Loss Account can be known by a number of different names, including a profit and loss statement, income statement, a statement of operation, a statement of financial results, an income and expense statement, or just simply as P&L. Either way, its the same thing – displaying whether your business has made a profit or a loss over a given period of time (typically a month, quarter or year).

It’s worth noting that the P&L is only one aspect of your company accounts and by itself, it cannot provide a complete picture of the health of your company. For example, you won’t find anything that your business owns or owes on your P&L; instead you’ll need to refer to the balance sheet for that information.

What is the purpose of a Profit and Loss Account?

The profit and loss account is an essential document that determines how profitable a company is. Keeping this document up to date over the months and years your business is in operation is not only a legal requirement in some cases, but it also benefits your business in several ways.

For example, by having access to an up-to-date P&L account, you will always have a clear, accurate and chronological record of how your business has performed, something that can be invaluable when making business decisions. So, if your business is making a profit you’ll be able to make sensible decisions regarding investing money back into the business. On the other hand, if you have more money going out than coming in, you’ll be able to see where spend is high, and potentially identify areas in which to cut costs. Accurate records are also essential when having conversations with potential investors, and new clients may request access before agreeing on new contracts.

The profit and loss statement also plays an important role for limited companies as they can only pay dividends to shareholders up to the limit of the profit the company has made after corporation tax, plus any profit from previous years that it has in reserve. This means the directors must check the profit and loss account to make sure that the company has sufficient profit available before declaring a dividend.

The profits shown in your P&L are also used to calculate corporation tax. Failure to file either of these correctly can result in having to pay added interest and penalties, so it’s important to get this report right. It will also help when it comes to completing your tax returns.

Once you’ve used the P&L account to calculate your profit or loss, this information will also feed into other key metrics, such as the gross profit margin, the operating profit margin, the net profit margin and the operating ratio.

What to include in your profit and loss account

It is critical that your P&L Statement follows the regulations in which it is domiciled, as these can vary from country to country. Most countries follow GAAP (Generally Accepted Accounting Practice), but there are always variations that must be taken into account. UK GAAP, for example, is the body of accounting standards published by the UK’s Financial Reporting Council ("FRC"). More information is available on the FRC's website at https://www.frc.org.uk.

In order to generate your profit or loss, your P&L report will start by calculating the total revenue (the total amount of money that comes into your business from sales) and take away any discounts or allowances (such as for bulk purchases). From this, the P&L takes away cost of sales, such as packaging and delivery, to show your gross profit.

Next, operating expenses are then deducted, which will include elements such as rent, wages and utilities, resulting in your operating profit.

If you have any other income, this is added to your operating profit to get to your profit before taxation.

After deducting tax, you are left with a net profit or loss.

Example profit and loss account

Profit and loss account for the year ended 31 December 2020

Turnover £100,000
Less: Cost of sales -£15,000
Gross profit £85,000
Less: Operating expenses -£50,000
Operating profit £35,000
Add: other income £5,000
Profit before interest and taxation £40,000
Less: Interest expense -£3,000
Profit before taxation £37,000
Less: Tax on profit -£7,030
Profit for the year £29,970

It should also be noted that the profit and loss report has an important role to play in demonstrating the evolution of a business. Hence, it’s usual to show figures from the previous period alongside the most recent set of data. Again, this will help you understand how your business is faring. So, if for example, gross profit has remained consistent over the past few years, but net profit is down, this suggests an increase in operating expenses which would guide you to look at possible ways to cut expenses.

How to maintain an accurate profit and loss account

Now that the importance of a profit and loss account is clear, how do you ensure it is produced accurately and simply when needed?

The first step is to ensure your records are well maintained at all times. Cloud accounting software such as AccountsPortal can be invaluable here, making it easy to track all money entering and leaving your business without the need for complex spreadsheets and manual processes.

The next step is to be clear about the time period your account is covering. You can then locate the revenue and expenses relevant to that period. Again, accounting software can simplify this process, with the ability to search for transactions within specified dates and then automatically generate your profit or loss.

Where is the profit and loss report in AccountsPortal?

You can see an overview of your profit and loss, including incomes, expenses and total profit or loss, from the main dashboard. For a more detailed look, navigate to Reports and click on Profit & Loss Statement in the Financial Reports section. Here you can refine your view by date as well as print and export the data.

Your profit and loss report is a key signifier of business performance. It can affect investment, the tax you pay, whether you attract new clients and so much more, so it’s essential that the records that feed into it are accurate and accessible.

Further Reading

A Guide to Sick Pay for the Self-employed or Company Directors

Should You Be a Sole Trader or a Limited Company?

How to Build Your Accountancy Team