What is a profit and loss account? | Profit and loss account example

Why is profit important?

It is important for a business to understand how much profit they’ve made to give it an idea as to whether the business is successful.

With so much money going in and out of a business, it is not always easy to see whether what a small business owner is doing is actually making money. By calculating profit, it helps give some clarity.

If a business is making a profit it can:

• expand and grow
• attract more investment
• employ more staff.

It is worth mentioning that profit is different to cash. Some things will affect the cash flow of the business, but won’t affect profit e.g. money taken out of the business for personal use. Likewise, some items will affect profit but will not affect cash such as provisions e.g. where a business makes an adjustment for a customer not paying.

How do I calculate profit?

This simplest formula for calculating profit is: total revenue – total expenses = profit.

Profit is calculated by deducting direct costs, such as materials and labour and indirect costs (also known as overheads) from sales. Under normal accounting rules, sales and expenses are included in profit when they occur, not when they are actually paid so profit will include credit sales and purchases, even when they are yet to be paid.

Here is an example. A business buys £3,000 of stock in January and agrees to pay for it in three months’ time. It sells the stock in the month in which it purchased it (January) for £5,000 cash. The profit for the month is £2,000. The fact that the stock wasn’t paid for immediately is not relevant when calculating profit. The profit that is calculated will derive from the ‘profit and loss’ account and will be calculated for a set period, usually a year.

Download: Profit and loss account example spreadsheet

Click on the download button below to access and use this profit and loss account example.

This spreadsheet will help you calculate your:

• Sales revenue
• Cost of sales
• Operating expenses
• Net profit
• Gross margin
• Net profit margin.

What records do I need to keep for sales?

Any money your business earns from selling goods or services in a trading year is known as turnover. Details of this will need to be included in your profit and loss statement.

To help you prepare your profit and loss statement you need to keep the following:

• sales receipts
• sales invoices
• credit notes and other sales documentation
• bank statements
• cash sales listings.

Most people use accounting software so do their bookkeeping as they go e.g. they write up their books periodically – daily or weekly etc. This makes it far less daunting when it comes to preparing the accounts.

What records do I need to keep for purchases and expenses?

To help you prepare your profit and loss statement you need to keep records of all your business costs such as:

• wages 
• utility bills
• material costs
• insurance 
• rent and rates etc.

If you are using accounting software you will process these periodically to ease the administrative burden at the accounting year end. Remember if you are VAT registered you will need to keep all of your VAT invoices for 6 years. Make sure that all of your invoices are valid VAT invoices where you have reclaimed the VAT.