Businesses must prepare several annual accounts every year. One of these is your balance sheet, which shows what you owe and what is owed to you, and another is your profit and loss account. In this guide, we’ll be looking at the profit and loss account to provide you with a better idea of everything you need to know.
Overview of Profit and Loss Accounts
The profit and loss account, sometimes abbreviated to the P&L account, essentially shows the details of everything your company has sold and its running costs. In short, it shows whether you have made a profit or a loss during the financial year. It can also be prepared over different periods such as monthly or quarterly.
Your business will only succeed if it makes a profit, which means generating more cash than you spend. As such, the profit and loss account is a measure of the financial health of your company.
What It Contains
The profit and loss account contains the details of your incomings and outgoings. It is divided into the following categories:
Sales
This covers your income from sales of products you have sold to your customers, even if you have not received the payment yet. For example, if a sale has been invoiced but not settled yet, it still goes in the profit and loss account.
It also includes income from other sources like interest the business has earned, rent or personal money you have put into it.
Cost of Sales
Cost of Sales refers to the costs related to selling anything that you make or sell. This includes equipment and supplies you need to create a product, manufacturing costs, distribution costs and equipment hire costs.
The total sales minus the total cost of sales will produce your business’s gross profit.
Additional Costs
Additional costs are also called overheads, and they refer to wages, bills, administrative costs, equipment, stationery and even your accountant’s fees.
Your business’s gross profit minus the additional costs will produce the net profit, and it’s this that is used to determine how much corporation tax you pay.
What Are Profit and Loss Accounts Used For?
The profit and loss account is very useful for any business, mainly because it provides an overview of the health of your business. When you create regular P&L accounts, you can quickly get an idea of the financial health of your business over a period of time.
Limited companies must produce profit and loss accounts every year for corporation tax purposes because the tax that businesses must pay will be based on the profits they make.
The profit and loss account is important for another reason if you have a limited company. Companies can only pay dividends based on how much profit they have made after corporation tax. So the directors need to make sure that there is enough profit in order to pay a dividend.
What If You Don’t Need to Produce a P&L Account?
If you are a sole trader or in a partnership, you do not need to produce a profit and loss account every year in the same way limited companies need to. However, it is still considered a very good idea to create these regularly for your own purposes.
As mentioned, they provide you with a clear overview of your business. They can also help you when you come to filling out your self assessment.
In addition, you will probably need to provide a profit and loss account when you apply for a loan for your business. So if you plan to seek a loan in the future, it’s a good idea to get into the habit of creating a P&L account regularly.
Investors may also want to see them in order to understand how the business is doing and how it has performed over time before they decide to invest.
But even if you do not need to apply for loans or seek funding, profit and loss accounts can simply help you to make better business decisions. If you are more informed about the financial health of your business, there will be less guesswork involved, helping with future planning.
Get Help from an Accountant
If you run a small business, you may be able to do your profit and loss accounts on your own. However, it can help to get assistance from an accountant.
The team at AK Tax can help keep all your financial records in order to make creating your profit and loss accounts easier. We will also help you to avoid making mistakes that could see you end up liable for penalties and additional taxes. So contact us today to find out how we can help you with all your business’s accounting and tax requirements.
