What is a profit and loss account?

What a profit and loss account means

The profit and loss account, also called an income statement, answers the question: did the business make money over this period? It lists sales at the top, deducts costs in stages, and ends with the profit or loss. It covers a period of time, unlike the balance sheet, which is a snapshot on one date.

How to read it, line by line

1. Turnover or revenue: sales for the period, excluding VAT
2. Cost of sales: direct costs of what was sold
3. Gross profit: turnover less cost of sales
4. Administrative expenses: overheads such as wages, rent and depreciation
5. Operating profit
6. Interest received and paid
7. Profit before tax
8. Tax: Corporation Tax for a company
9. Profit for the year, which is added to retained earnings

Example

A small company's P&L for the year to 31 March:

A 60% gross margin and a 16.7% operating margin. Up to £30,780 could be paid as dividends from this year's profit, if cash and earlier reserves allow.

Why it matters for your business

The P&L is the report most owners look at first, and for good reason: it shows whether pricing, costs and volume add up to a profit. Comparing it month by month in management accounts, and against budget and last year, shows trends early. It is also the starting point for Corporation Tax or income tax, after adjustments for items HMRC treats differently, such as depreciation and entertaining.

Remember that profit is not cash. A profitable P&L can sit alongside a shrinking bank balance, which is why it should be read together with cash flow.

Common year-end adjustments

Before a P&L is final, the bookkeeping is adjusted for stock at the year end, accruals, prepayments, deferred income, depreciation and any bad debts. Without them, profit can be overstated or understated by a large amount, and so can the tax bill based on it.