The profit and loss (P&L) account of a company is a statement of the financial performance of the company over a given period. It is the aggregate of all income and expenditure of a company and highlights certain key profit points.
Various forms of P&L account exist, but we principally deal in either a statutory format as found in a set of company accounts, or in bespoke format tailored to suit the operations of a particular business: both share common elements but the tailored format is designed to show the business the elements that are most important and likely to be in greater detail than the statutory format.
In a set of company accounts the P&L account usually covers a 12 month period and is displayed in a format similar to the one below:
|Profit & Loss Account|
|Year ended 31 March 2018|
|Year ended||Year ended|
|Cost of sales||(2,547,963)||(2,568,963)|
|Profit before tax||2,287,718||1,667,149|
|Result for the year||1,853,052||1,350,391|
What does a P&L contain?
The general principle is that revenue is at the top, followed by all the costs of the business, from raw materials and direct labour costs, through premises costs, overhead staff costs, etc – until all the company expenses have been identified and deducted from revenue. The value by which revenue is greater than all the costs is the profit (or ‘loss’ if revenue is less than costs): hence profit and loss account.
The value by which revenue is greater than all the costs is the profit (or ‘loss’ if revenue is less than costs): hence profit and loss account.
Why is profit not cash?
We are asked this question a lot and, unfortuantely, profit does not necessarily equal cash.
There are many reasons for this but the main reason is the provision of credit terms. Any time that a period of credit is granted will give rise to a timing difference between when the sale was made (and invoice sent out) and when you were paid for the goods or services provided.
If your business is based around buying and selling, only for cash, then there is a fair chance that your profit will equal your cash balance – however in reality this is rarely the case. Take a small construction firm for instance: they probably have a trade account at the local builders’ merchant which grants them 30 or 60 days credit, meaning they can order materials, carry out the job and get paid by the client, before they have to pay for the materials they used. Just because they have not yet paid for them does not mean they are not part of working out the profit on the job; they know they have to pay for them sometime.
Key subtotals and ratios
There are a few key subtotals found on a P&L that are used to judge the performance of a business, together with their ratio to revenue:
Gross profit: The total revenue less the direct costs of providing the service or making the product. So for a baker this would be the selling price of the bread, less the cost of the ingredients, labour and packaging. It shows how much of a premium a company can charge for the product or service it supplies (and is often compared with other businesses as a gross profit percentage, where gross profit is divided by revenue to give a relative percentage). Going back to the example then, a baker sells a loaf of bread for £1, which cost 18p to make and 3p to package. His gross profit is 79p and the gross profit percentage is 79%.
EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation): this is a crude measure of cash generation of the underlying trade or business, without looking at the cash flow statement. It is calculated by taking the gross profit (as established above) and removing all the operating costs of the company; rent, wages, travel, light and heat etc.
EBITDA is often used as the basis for business valuation, so understanding what EBITDA means is important for many business owners
Profit after tax: this is EBITDA, less interest and some other non-cash costs; and of course corporation tax. The profit after tax is the last number at the bottom of the P&L; and the cumulative balance on this reserve is the maximum dividend that can be declared for the shareholders (subject to the cash in the bank being available).
P&L as a business management tool
To successfully manage a business it is vital to be able to read and understand a P&L account. Once you do, you will be able to drill down into any of the component figures to understand where you can make the business more profitable. For more information about how a bespoke P&L can help you take hold of your company finances, have a look at our management accounts page. Relevant and timely management accounts can help a business owner really understand where their business makes money (and where they are not getting a great return on their investment).