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Finance for non financial business owners

posted 14 Jun 2013, 09:36 by Richard White   [ updated 17 Jun 2013, 07:38 ]

The Profit & Loss Account 

Whatever your line of business, you need to be conversant with the basics of financial management. Armed with this knowledge, you will be better placed to judge a company’s performance and take steps to develop strategies for the future.

We start with perhaps one of the most important financial statements – the Profit & Loss Account.

What information does the Profit & Loss Account give us? 

The Profit & Loss Account gives a view of a company’s trading performance over a period of time – typically a year for statutory financial statements which need to be filed at Companies House or perhaps quarterly or monthly for management accounts used for internal decision making.

What headings can you expect to see in the Profit & Loss Account?

Headings in the Profit & Loss Account will typically include the following:

·        Sales (also known as turnover)

·         Direct Costs and Overheads

·         Profit or Loss

·         Tax charges for the period

How the Profit & Loss Account is prepared

The Profit & Loss Account is prepared under the accruals accounting principle rather than on a receipts and payments basis. Items are recorded when incurred even if they have not yet been paid. For example:

·         Sales and Purchases are included when invoiced (rather than when paid)

·         Costs of buying Fixed Assets are spread over the useful economic life of the assets (rather than being charged to the Profit & Loss Account in the period in which they are bought). Instead a depreciation charge is made to the Profit & Loss Account in each accounting period which spreads out the cost over the life of the asset

·         Prepayments are made for example where rent is charged in advance and accruals are made for example to account for professional fees which have been incurred but have not yet been invoiced.

Cash transactions which do not affect the Profit & Loss Account are not included. For example a cash injection of £100k from a new loan would not be included, but £1k worth of interest costs relating to the loan would be included as a cost in the Profit & Loss Account.

What are profit margins and why are they useful?

You can calculate profit margins from the Profit & Loss Account – they give a view on the comparative profitability of the business.

Gross Profit Margin

The Gross Profit Margin or GP% is expressed as the Gross Profit as a percentage of Sales. For example a business with Turnover of £400k and Cost of Sales of £120k would have a Gross Profit of £280k and a Gross Profit Margin of 70% (calculated as £280k divided by £400k).

Operating or Net Profit Margin

The Net Profit Margin is expressed as the Net Profit (after charging overheads as well as cost of sales) as a percentage of Sales. For example a business with Turnover of £400k and Net Profit (after overheads) of £60k would have a Net Profit Margin of 15% (calculated as £60k divided by £400k).

Using margins to measure profitability

You can use profit margins to get a clearer view on the financial performance of your business by:

·         Comparing them to similar companies (for example to those of your competitors)

·         Comparing them to your own profit margins from previous periods (to get a feel for the trend – is your business performance improving or do steps need to be taken to get performance back on track)

·         Comparing the profit margins achieved on different products or services – which products give the highest return – which are the stars to focus on and which ones should be phased out

Break even analysis

The Profit & Loss Account can help show you how much scope you have to alter your prices and what level of sales your business must achieve in order to ‘break even’ or in other words cover all its costs. Break even analysis can show the risk inherent in any business model by comparing the current sales levels to break even sales levels and just how much room there is for movement before a profitable business becomes loss making – or vice versa!

If would like us to help please get in touch

If you need help with preparing the Profit & Loss Account for your business, calculating or interpreting your profit margins or your break even analysis, then Ellingsworths Chartered Certified Accountants can help. 

Ellingsworths are accountants based in Wolverhampton and serving the West Midlands area. 

Just call one of our friendly team on 01902 896 730 or email us on enquiries@ellingsworths.co.uk 

We will be delighted to help.

No part of this website may be reproduced or transmitted without the written permission of the publisher. This website is for general guidance only. The publisher, Ellingsworths Ltd Chartered Certified Accounts disclaim all liability for any errors or omissions. Consult your local business support organisation or your professional adviser for help.

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