What is a profit and loss account?

The profit and loss (p&l) account is usually presented as a statement and shows the business activity and associated expenses of an organization over a defined period of time.

A typical p&l will contain the following:

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It is the turnover of the business, the main source of income from the sale of products or services. This figure is always net of taxes since these are payable to the government and are not part of the company’s income.

Purchases (stock/inventory)

Purchases are the stock items that you buy to sell to customers. A basic accounting principle is that revenue is exactly matched to the cost of generating that revenue. In this regard, stocks or stocks on hand at the end of the accounting period are always deducted from the total cost of purchases. These in-stock items will be used to generate future sales and will be compared to those sales in the next period.

Sales-related expenses

These costs are those that are incurred directly in the process of making a sale to a customer. They include items such as sales commission, promotional costs, and courier charges.

General expenses

Finally there are general business expenses. These are the costs incurred in the rest of the business that are not directly related to the sales process. Examples of overhead costs are: administrative staff salaries, lighting and heating, office supplies, computer maintenance, and legal and accounting fees.

Two versions of the profit and loss account

In published accounts, the p&l account has a standard format, this is to help the understanding and interpretation of the information. The accounts are typically known as financial (or statutory) accounts and are subject to applicable legal and accounting principles.

However, to really understand how your business is performing you need to prepare a fully detailed profit and loss account, this is an expanded version of the published accounts and usually has additional information such as ratio analysis and key performance indicators.

This version is often referred to as “management accounts” simply because they are figures for management and not external publication. Therefore, there are no regulatory guidelines on its composition to worry about.

Management accounts are the tool you must have to see if your business is profitable and are normally prepared on a regular basis, usually monthly, for each of your product lines. The p&l is a central part of the management accounts package.

Periodic review is necessary because you need to be aware of areas that are not meeting objectives as soon as possible; so you have time to take corrective action before the end of your tax year. For example, if a regular customer has started ordering erratically, he may find upon investigation that he is testing one of his competitors. This gives you the opportunity to run some special promotions or renegotiate the deal with your customer to win back your competitor’s business.

Plus, you’ll find that budgeting is a valuable tool for your business. A budget is a financial plan for the coming year. Creating a budget allows you to review all areas of your business both to make sure your existence is justified and that you are making the most of your assets or resources.

During the year, you compare your actual results with your budget and investigate where the results have not turned out as planned. Examples of problems could be cost overruns due to inefficient ordering or unnecessary use of more expensive components. Again, this review process gives you time to make changes before problem areas get out of hand.