FINANCIAL LITERACY • 29 APRIL 2024 • 2 MIN READ

What is a profit and loss account?

SECTIONS

What makes a profit and loss account the most useful financial statement?

Who uses a profit and loss account?

What’s included in a profit and loss account

Before we say anything – let’s establish that a profit and loss account is known by a few other names:

Income statement
P&L statement
Statement of income

It’s one of the critical financial statements that every business must prepare at the end of each financial year to assess financial health and calculate taxable income. Collectively, these financial statements cover assets, liabilities, revenue and expenses. Whereas the balance sheet covers the asset and liability components, the profit and loss account handles revenue and expenses.

What makes a profit and loss account the most useful financial statement?

By reporting on income and expenses, the statement calculates a business’ net profit.

In addition, it breaks down income and expenses to a granular level. Accountants and business owners can use these details to identify opportunities for optimisation. They’re able to analyse:

Revenue - perhaps split down into revenue streams for different products or services, or geographical regions
The cost of sales (or manufacturing expenses)
Operating expenses (including overheads such as rent and utilities, training costs, support staff wages)
Non-operating expenses
Director and staff salaries
Other sources of income such as bank interest
Finance charges and taxes

Who uses a profit and loss account?

A range of users are interested in the profit and loss account.

Those interested in your profit and loss account include:

Accountants – when preparing your company’s corporation tax return
Banks – to see whether the business is making enough profit to repay a loan and interest
Potential investors – checking how profitable the business is
Shareholders or potential investors looking at investment opportunities - – will the company have sufficient profits left over to declare a dividend?
Management – comparing the actual figures against the budget
Business owners – investigating unusually high expenses and also forming their budget for the coming years

What’s included in a profit and loss account

We’re about to break down exactly what makes up your profit and loss account.

But first, a note.

If you’re using automated accounting software, you may want to double-check that you’re correctly classing each expense as direct costs (which impact gross profit) and operating/overhead expenses. You can find instructions on how to do it in Xero, here.

Income

Also known as sales or revenue, income can come from:

Selling goods
Providing services

Cost of sales / Direct costs

These expenses relate directly to the sale of goods or services*.

Opening stock
Purchases of goods (products to sell)
Purchase of raw materials (for processing, then selling)
Purchases of materials (materials used in the construction industry)
Freight and packaging – bringing materials and goods to you, and delivering to customers
Commission paid to salespeople
Contractors and subcontractors
Maintenance of factory plant and machinery (the more units produced, the more maintenance is required)
Wages for factory workers (if they’re based on units produced, rather than per hour) or workers directly invoiced in producing the product, or providing the service, that you sell
Closing stock

Gross profit

After deducting any costs of sales from income, you have the gross profit. From gross profit, you will then deduct your operating and non-operating expenses.

Operating expenses

These are costs that generally remain consistent, no matter the level of sales.

Advertising
Bank fees
Computer and IT expenses
Insurance
Interest
Office rent
Power
Printing, postage, and stationery
Professional fees (legal, accounting, consulting)
Telephone and internet
Salaries
Staff expenses

Directors’ and shareholders remuneration (for companies)

A director of a company is remunerated by way of a salary paid via PAYE; salary is a tax-deductible expense that will be shown in the profit and loss statement.
A shareholder can extract profits from the company by way of a dividend. These are not tax-deductible expenses.
An individual who is both a director and shareholder of a business will therefore be likely to take a mixture of salary and dividends in a manner that minimises tax.

Non-cash expenses

Depreciation of property, plant, and equipment
Amortisation of intangible assets such as IP or patents
Gains or losses on the sale of assets
Certain accountant adjustments

Accruals for expenditure or income not yet paid for or received that needs to be reflected in the accounts
Deferred income and expenses for income received, or expenses paid that should not yet be recognised in the accounts.

Net profit (loss) before taxation and adjustments

Net profit before tax per the profit and loss is the business income less all expenses and accounting adjustments.

In order to get to your taxable income that is included in your tax return and on which you will ultimately pay tax, a number of adjustments are needed, including the adding back of non-deductible, or disallowable expenses.

Non-deductible expenses

These are business expenses that can’t be deducted from taxable income:

Non-staff entertaining costs
Certain legal expenses
Certain fines and penalties
Initial costs of setting up your business

Net profit or loss for the year

Once you have calculated your tax liability, you will then deduct this from your net profit before tax on your P&L, to give you your net profit (or loss) for the year.

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Charlotte Wass

General Manager, Beany UK

Chartered Accountant and Chartered Tax Adviser based in London. I love autumn, otters and Malteasers, and I hate spiders, peanut butter and the London Underground.

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