Your Profit & Loss Account - Understanding your business performance

Your Profit and Loss (P&L) account is one of the most important financial statements of your business and shows all your transactions in the business and profitability.

The P&L account shows revenue and expenses of your business, and most importantly over a period of time, a month, a quarter or year.  Looking at your P&L in a period of time is useful as a comparison point, so for example  you may want to compare your P&L this March from last March to see if you are achieving your business goals.

Investors and other interested parties, maybe a mortgage advisor, do look at your p&L to understand how your business is run, so it is a really important aspect of your business external financial reporting.

A closer look……

P&L can be deceptive, it looks at first like a simple list of incomings and goings, but actually is more complicated than it looks.

First on the P&L report is all income received by the business, including sales or revenue, as well as non trading income, like bank interest.

Next up is Cost of Sales. These are direct cost of achieving revenue of your product or service.  This can include labour, materials, any equipment bought to produce a product for onward sale, shipping costs to bring materials to you and so on.  All these examples are direct costs for you to deliver a product or service for onward sale.

Gross profit

Direct costs minus from your sales figure gives you your gross profit.  Gross profit is a really important and revealing number as it can tell you how efficient your business operations are.

For example, say you made sales of £50,000, but your direct costs were £40,000, your gross profit would only be £10,000, which is relatively low versus your sales figure.   You may want to look at your direct costs, negotiate better prices with your suppliers for example, and look to increase your gross profit number.   It could be that you anticipated this low profit margin in the first year as you are a start-up, but you plan to grow your gross profit from year 2 onwards when you are up and running.

Net Operating Profit

Next up you have indirect costs, like insurance, marketing, rent, telephone, working from home, stationery, travel and so on.

You take these indirect costs from your gross profit number and if you have a positive number, then you have profit, or operating profit.  If this is a negative number, you have an operating loss.  

Cash flow versus Profit

So how is the P&L report different from cash sitting in your bank statement? How can you have, for example, a high profit, but less or cash in your bank account?

Firstly, no everything you buy from the business is recorded in your P&L, for example, assets are recorded on your balance sheet.

Also, you may employ the accrual basis if you are a limited company for example, which is an accounting method where you record what happens in a business in the P&L, in other words all transactions, not what comes in and out of the bank account necessarily.  So say you invoice your clients for a service or product you offer, this would be recorded as a sale or revenue in the P&L even if the client hasn't paid you yet. 

So if you ever ask yourself why do I have a high profit in my P&L account but no money in the bank or visa versa - this is why!

Your bank account shows how much cash you have to keep the wheels of your business machine moving, whereas the P&L, which forms part of your financial accounts, shows what has happened in the business in a certain period of time.