Understanding profit and loss account statement
Understanding profit and loss account statement in addition to your balance sheet is a key part to running a successful business.
In order to know where your business is going financially, you need to know firstly whether you are making or losing money. Having a healthy bank balance is a good indication that you are making profits. But this may not always be the case.
Additionally, you need to understand where you are making money. You also need to know which products or services you supply make money.
It’s no good making good profits on one line, only to be making losses on another product line.
Typically your profit and loss will measure how much money you have made or lost over a given period. The period measured is usually over a month or for 12 consolidated months. Most profit and loss statements benefit by having comparative figures so you can compare periods.
What do you spend your money on in your business?
What are you spending your money on? Look at both the current year and the comparative and review your expenditure. The profit and loss account is a useful tool for analytical purposes.
You also need to know where you are spending your money. What you’re spending your business profits on will be detailed on your profit and loss account.
The benefits of producing accurate and up to date financial information allows you to know exactly how much money you are making (or losing). It will also allow you to begin to analyse where you could make yet more money. This is especially true if you begin to focus in on the 7 ways to grow your business.
More reasons for having up to date financial information
Another reason to have accurate financial information to keep your bank manager informed. There are many times other interest parties too. These can include investors and other lending institutions who like to be well-informed. Lenders and investors will use your financial information to see clearly how the business is doing.
Your profit and loss account in conjunction with your balance sheet reports, will provide sound business information for you and for your bank and/or investors.
What are your metrics or KPIs? Your profit and loss not only measures your profitability, but it will also show you your margins, including your Gross Profit Margin and your Net Profit Margin.
Measuring business profitability and business financial health
Your profit and loss measures your business profitability. Whilst your balance sheet measures the businesses financial health.
Use both these reports in combination with each other work well to monitor how well the business is performing.
To prepare a profit and loss account and balance sheet you will need to invest in some accounting software. P & L and balance sheet reports are standard in most accounting packages. I also suggest nut necessarily starting out from scratch with an Excel spreadsheet. This is unless you manage to get a good template to work with.
The above is an example shows the contents of a profit and loss account. This is for 12 months with the penultimate month as the comparative.
The report is split between the top half of the P&L or above the line. The top half shows turnover (sales), less cost of sales and gross profit.
Cost of sales is made up of those direct costs incurred in make the sales. For example, if you sell widgets at £100 each and they each cost £40 to buy, your cost of sales would be £40. In this example your gross profit would be £60 (i.e. £100 – £40 = £60). This would mean your gross profit margin is 60%.
Below the gross profit are listed your overhead expenses. These are summarised in the above example into headings that include Wages & salaries, General Overheads, Financial overheads and Depreciation.
How to grow your profits when you know what they are
Once the total of these are deducted from your gross profit you’re left with net profit. Also referred to as your profit before tax.
With your profit and loss account information. Plus having your profit with your sales data. Together with key client data; including the average transaction value; the number of times customers return; the number of customers you have. You’ll be able to calculate the best way to grow your business using our Increase Profit Software.
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