Typically, SMEs need to remain in profit to survive. A profit and loss statement shows what your company has earned and spent over a specific period of time and, crucially, whether it is showing a loss or a profit.
This makes it a great overall indicator of business performance. “With SMEs, you need regular profit and loss reports to ensure you have early warning of any dip in profitability,” says Neil Hutchings, director of corporate finance at Albert Goodman – a long-standing accounting firm based in the south-west of England.
What is a profit and loss (P&L) statement?
A profit and loss statement is a document that details revenues, costs and overall profit or loss. The document is sometimes referred to as a P&L statement, income statement or statement of earnings/operations. These terms are interchangeable, says Hutchings, and refer to the same thing. However, it’s important to note that a P&L statement is not the same as a cash flow statement – which only tracks the movement of cash in and out of the business.
How do profit and loss statements work?
Profit and loss statements differ depending on the business and industry, but will generally list the major categories of revenue, spending, and expenses incurred by the business.
- Revenue: this section of the P&L itemises major revenue categories such as the company’s earnings from products, services, and consulting.
- Cost of Goods Sold (COGS): the P&L statement will list the costs incurred in selling products or services, which will include things like material, labour, and distribution.
- Expenses: These are costs incurred by the business that are not directly related to the sale of goods or services, such as property, travel, and administrative expenses. It should also capture details of taxes paid.
Example of a profit and loss statement
This P&L example shows how a company could show revenue, cost of goods and expenses over a single year to reveal overall net and gross profit.
Profit and Loss for Year Ending April 2022 Total sales £200,000 Other business income £10,000 Total turnover £210,000 Total cost of sales £60,000 Gross profit £150,000 Travel expenses £5,000 Payroll expenses £12,000 Labour costs £10,000 Rent, rates, power £6,000 Office and admin costs £4,000 Interest costs £1,000 Other business expenses £2,000 Total expenses £40,000 Net profit/loss £110,000 |
Importance of preparing profit and loss statements
Regular P&L reviews can help inform better business decisions and outcomes as they allow SMEs to understand their earning power over a set period, typically a year or quarter. “We don’t have any external funding, so it’s essential we are always in profit, and check our P&L regularly,” says Anneke Short, co-founder of independent watch brand The Camden Watch Company. “If we see profits dip, we drill down into the data to see what’s happening. Do we need to adjust the price of a product because of higher costs, for example? Or is there a decline in demand that we need to address through marketing?”
Types of profit and loss statements
A profit and loss statement can take several forms. The main types of profit and loss statements include:
Single Step income statement
This is a simplified P&L that shows revenue, expenses, and net income. This is the sort of document commonly filed to Companies House.
Multi-Step income statement
This splits revenue into operating and non-operating heads to give a more accurate view of the operational health of the business. This is useful in allowing a company to understand trends in profit outside of one-off costs that aren’t related to ongoing business activities, such as investing in new properties.
Comparative income statement
This shows trends in profit/loss between comparable time periods. It can be useful in identifying trends over time, such as the impact of competition from other businesses in your sector.
Common Size Analysis Profit and Loss statement
This uses percentages (rather than figures) to show the proportion of income and expenses allocated to various categories. This is useful when benchmarking your business against others in the same industry.
Variance Profit and Loss statement
This shows the variation between what you expected revenue and expenses to be, and what they actually showed as. This means you can compare profit projections with actual profits achieved and achieve better projections in future to assist with business planning.
Composite profit and loss statement
Finally, a composite P&L statement is a highly detailed account of multiple items across several time frames, using both financial and non-financial metrics. It is most commonly used to identify items within cost categories by grouping together entries like 'digital marketing' separately from 'print marketing'.
How do you prepare a profit and loss statement?
Most mainstream accounting packages will generate a P&L statement automatically at the end of each quarter and year, says Hutchings. You can also view ad hoc P&L reports tailored to the information you need at any given time. For example, you might want to understand how your property costs are contributing to overall performance if you’re considering relocating, or scrutinise labour costs before expanding your workforce.
If you don’t have accounting software (or an accountant), you can prepare your own P&L by following these eight steps:
- Decide the period your profit and loss statement will cover.
- Calculate the company’s total revenues for that period.
- Look at total expenditure for the same period.
- Identify which are direct costs (i.e. related to the sale of goods/services).
- Deduct these direct costs from revenue to determine gross profit.
- Next, identify the regular operating expenses of the business.
- Deduct operating and direct costs from revenue for EBIT (earnings before interest and tax).
- Finally, calculate net profit by deducting indirect expenses from the gross profit.
How to use your profit and loss statement
When you receive a P&L statement, it’s important to consider what insight it offers, says Hutchings. For example, early signs of a decline in demand for a particular product could suggest it is priced too high to be competitive, or that the marketing for the product needs refreshing.
P&L statements can also identify opportunities. “A peak in demand can often suggest you are priced competitively, and there could be room for a price increase, or an opportunity to broaden a product range,” says Hutchings. “It’s about having that information and being able to move quickly, especially in such a fast-moving economy.”
For the Camden Watch Company, tracking P&L was an essential step in preparing for its recent Kickstarter funding campaign, which invited customers to pre-purchase its first Swiss-made watch at a discount. The company relied heavily on its profit and loss statements and the trends they revealed over time to understand what funds it needed to raise.
“We couldn’t just pick a number out of thin air and hope that it would be enough to develop this new product," says Short.
"We had to look carefully at what resources we had, what costs were involved in getting this new product to market, and what minimum order quantity would make the project viable."
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