Profit and Loss (P&L) Accounting Guide

   

When you’re trying to work out how well your business is doing, one of the most powerful tools in your financial arsenal is your profit and loss account (P&L).

This is a simple set of figures that will give you a summary of what your business has spent and sold, normally in the previous 12 months.

By deducting what you’ve spent from what you’ve sold, you’ll discover what profit or loss your business has made. It really is that simple.

Limited Companies must produce a profit and loss account every year

If you run a limited company you will need to produce a profit and loss account every financial year to give to Her Majesty’s Revenue & Customs (HMRC). They will use it to assess your business for corporation tax.

If you are self employed or in a partnership, you probably won’t have to produce a formal P&L. But it’s a good exercise to go through anyway, as it shows you what’s happening in your business. Plus the information you prepare will help you fill out your self-assessment tax return.

A P&L will also be necessary if you want to apply for a mortgage, take out a loan, or get other financing for your business.

A good P&L starts with accurate financial records

A good profit & loss sheet starts with keeping accurate financial records. This is something that is required by law, and it means getting a receipt for everything you buy, and keeping a copy of every sale or invoice you issue.

You should also keep records of any other income you get, how you spend petty cash, and personal payments made for goods (for example if you run a shop, you need to record when you take goods and how you pay for them).

If you run a limited company you will also need to keep a record of any money you take out of the company for personal use, or any personal loans you make to the business.

You categorise revenue in one of two ways, and expenditure in one of three ways to create your P&L:

Business income – sales

You need to keep a record of all sales within the business with documents to back that information up. If you run a shop, your till roll will be the documentation. Or if you issue invoices, they will count. You also need to keep paying-in slips and all your bank statements. These all work together to prove how much money is coming into your business.

Business income – other

On top of sales, you might get income from other sources. For example your business might earn interest on bank accounts, or you may rent part of your premises out to other businesses. This is where you record personal money you put into your limited company.

Cost of sale

This is the first way of recording money out of your business. It relates to the basic cost of creating your product. For example, if you get an order for 10 widgets and so have to buy 10 tubs of goo, those tubs are counted as cost of sale. You wouldn’t buy them until you needed product.

There are other cost of sale items, including labour to produce it, machine hire and some other production costs. Cost of sale does not normally apply if you only deliver a service.

Business expenses

These are all of the ongoing expenses that you must incur to run your business, such as premises, employees, and general administration. Your accountant will advise which expenses should be recorded here. Sometimes expenses are not allowed for tax purposes and have to be added back before your taxable profit is calculated – again your accountant will advise how this affects you.

Cost of equipment

Finally, you record the costs of any equipment you have bought or leased for long-term use. These items are known as fixed assets or capital items, and might include computers, vans, furniture and machinery.

Rather than record the financial hit of a piece of equipment in one year, you can spread it over a number of years. For example if you buy a computer for £300, you might decide to account a cost of £100 for three years. This is known as depreciation. Bigger businesses need to keep a fixed asset register.

Now you have categorised all your sales and costs, you can work out your profit & loss.

The sales and other income are added together to create a figure known as your turnover. If you then deduct the cost of sale, this is your gross profit. Finally, deduct business expenses and cost of equipment to get your net profit. This is the figure you will be taxed upon.

Remember to get professional advice from a qualified person before taking any action. Don’t rely purely on information contained in this article.

Posted November 1, 2007

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