Our frequently asked accounting and bookkeeping questions blog series is part of The Accountancy Partnership’s business resources. We’ll help you understand commonly used accounting terms and practices, as well as providing more information about online accountancy services.
In this article we explain profit and loss. Let’s go!
What is profit and loss?
A profit and loss statement, also known as an income statement, is a summary of a business’ sales, minus its expenses.
It will usually show the figures over a particular period of time, such as a month or a financial year.
What is the purpose of a profit and loss statement?
Profit and loss statements are a useful way of understanding how a business is performing financially. In essence, it shows how much the business has left over after the expenses have been deducted from the income.
Comparing a profit and loss reports against reports from previous periods will also help you spot any trends, and provide insight about areas that need to be addressed or improved.
Understanding your P&L statement
Spending versus expenditure
It’s useful to note the difference between spending and expenditure, especially when dealing with P&L reports. A business can incur expenses, without actually having spent the money yet.
For example, when a supplier submits an invoice, you incur the expense at the date of the invoice – but you might not spend the money to pay it for another month. When you think about profit and loss, consider all of your expenses, even the ones not yet paid.
It works the other way, too. When the business invoices a customer it’s counted as income even if the customer hasn’t paid it yet.
Cost of sales and expenses
The costs of sales, also known as the direct costs, are the costs directly linked to a particular sale. For example, the raw materials needed to make the product, or the cost of the labour needed to build it.
Expenses are all of the operational costs of the business which don’t directly relate to its sales, such as stationery or renting office space. You might also hear them called indirect costs or overheads.
Gross profit and net profit
When you review your profit and loss report it’s useful to look at the gross and net profit separately. This can help you identify where the business is running efficiently, and where it might need improvement.
The gross profit is the business’s income, minus the direct cost of sales. Net profit is what’s left over after all of the other expenses have been paid too.
How do you calculate profit and loss?
To manually calculate your profit or loss:
Add up all of your income over a specific time period, to work out your total income.
Add up all of your expenditure over the same time period to work out your total spending.
Subtract your total spending away from your total income. A positive number means you’ve made a profit. A negative number means you’ve made a loss.
You can also use accounting software to calculate profit and loss. Our accounting software Pandle, includes reporting tools which enable users to easily produce reports at the touch of a button.
It uses the transaction and invoicing data to work everything out for you, as well as showing the breakdown of sales, direct costs, and expenses involved.