A profit and loss statement shows how much your business earned, what it spent, and what was left over during a period such as a month, quarter or year. It answers the question of whether the business made money.
It is one of the main reports in your annual accounts and your management accounts. Reading it well helps you spot problems early and make better decisions.
How it is laid out
Most profit and loss statements follow the same order, starting with income and working down to profit:
- Turnover. Your sales for the period, excluding VAT.
- Cost of sales. Costs that rise and fall directly with sales, such as materials, stock, subcontractors and direct labour.
- Gross profit. Turnover less cost of sales.
- Overheads. The costs of running the business, such as rent, salaries, insurance, software, marketing and professional fees.
- Operating profit. Gross profit less overheads.
- Interest. Costs of borrowing, such as loan and hire purchase interest.
- Profit before tax.
- Tax. Corporation tax, for a company.
- Profit after tax. What is left for the owners.
A worked example
A small manufacturing company has the following results for the year:
- Turnover: £500,000
- Cost of sales: £300,000
- Gross profit: £200,000, a gross margin of 40 percent
- Overheads: £140,000
- Operating profit: £60,000
- Interest: £5,000
- Profit before tax: £55,000, a net margin of 11 percent
- Corporation tax: £10,825
- Profit after tax: £44,175
The corporation tax assumes taxable profit is the same as accounting profit, with marginal relief applying because profits are between £50,000 and £250,000. In practice, adjustments such as depreciation and capital allowances mean the two figures usually differ.
Gross margin
Gross margin is gross profit as a percentage of turnover. It shows how much of each pound of sales is left to cover overheads after paying the direct costs of making the sale.
A falling gross margin usually means prices have not kept up with costs, discounts are too generous, or there is waste or theft. Because it is so closely linked to pricing, it is often the first number to look at. For it to be meaningful, costs need to be coded consistently between cost of sales and overheads.
Overheads and net profit
Overheads tend to be fixed in the short term. Watch for costs that creep up without anyone noticing, such as software subscriptions and insurance renewals.
Net profit, the profit before tax as a percentage of turnover, shows how much of each pound of sales the business keeps. Comparing it over time tells you whether growth is actually making you better off.
What the profit and loss does not show
- Cash. Profit is not cash. Sales are recorded when invoiced, not when paid, and costs when incurred. A profitable business can still run short of money.
- Dividends. These are paid out of profit after tax and do not appear as a cost. Directors' salaries do appear, within overheads.
- Asset purchases. Buying equipment does not appear as a cost straight away. It goes on the balance sheet and is charged through depreciation.
- Loan repayments. Only the interest appears, not the capital repaid.
Read the profit and loss alongside your balance sheet and cash flow to get the full picture.
What to do
- Look at your profit and loss at least quarterly, and monthly if you can.
- Compare each period with the same period last year and with your budget.
- Track gross margin and net margin as percentages, not just pounds.
- Ask about any line that has moved significantly and you cannot explain.
If you would like help getting more from your management accounts, book a free call.
