The Profit and Loss Account

Cellstudy™ in association with the Tax Academy™

The profit and loss account (also known as the ‘income statement’) with the balance sheet (covered last month) and cashflow statement forms part of the ‘holy trinity’ of financial statements.

The profit and loss account is often the most popular of the three statements as it ‘drives’ the business plan and in particular how much profit or loss will be generated by the business. Combined with the balance sheet and cashflow statement they provide an in-depth look at the performance of the business.

The profit and loss statement summarises the revenues, costs and expenses of the business over a period of time. Key business decisions are made on these statements and when writing a business plan for investors, they will need to see, amongst other things, the projected profitability of your business.

The profit and loss account only shows ‘revenue’ and ‘expense’ transactions that are related to the commercial activities of the business. This means that money injected for instance into the business in the form of loans or major expenditure on capital equipment will not be shown here but rather in the balance sheet and cashflow statement.

Whether you are operating a limited company or sole trader, the essentials of the profit and loss account remain the same. The profit and loss account tells part of the financial story of your business over a period of time, typically one year.

The profit and loss account can be split into two main categories:

• The trading account

• Administrative expenses

 

The Trading Account

This forms the top section of the profit and loss account as it forms the ‘direct’ trading activities of the business.

 

Sales (also known as ‘the top line’)

This includes all the work you have invoiced to clients and is shown net of VAT. It also includes work that you have undertaken but not yet billed – work in progress.

 

Cost of sales

This represents the direct costs that have been incurred to generate your sales, including where appropriate the amount of stock that has been used.

 

Gross profit and gross margin

Gross profit is the difference between the sales and cost of sales and together with the gross profit margin (gross profit/sales) form probably the most important indicators of your business. For instance, investors will look at your gross margins and compare them with similar businesses to ensure that the underlying margins are correct. In particular, the gross margin can show whether you are correctly pricing your product or service.

 

Administrative expenses

Administrative overheads are essentially the business overheads of your business, including costs such as rent and rates, heat and light, motor expenses etc.

 

Operating Profit

The operating profit is the gross profit less administrative expenses with the operating margin show being a key performance indicator (KPI) and can be used as a comparison against previous years and other businesses within the same sector.

After the charge for taxation, the resulting profit is the profit for the financial period.

Once again, the net profit margin is a KPI that can be used to compare the profitability of the business against other companies in your business sector.

 

Get your tax affairs in order pre-release

5 April 2019 marked the end of another tax year – 2018/19

Remember to contact The Tax Academy CIC to review your tax affairs to ensure they are up-to-date. There is nothing worse than being released from prison and finding that you have tax penalties and tax debt that need to be resolved with HMRC.