Creating Profit and Loss Accounts

Our profit and loss summary article provides a basic overview of what profit and loss accounts (P&L accounts) are and how they help you keep track of your business' financial situation.

Your P&L is an annual statment that covers a 12 month period.  If you’re a sole trader it’s easier for your profit and loss accounts to follow the tax year, ie starting on 6 April. If you're a limited company you could choose to have 31 December as your year-end date, or the end of tax year date.  It's quite common therefore, that the first profit and loss accounts for a business will not cover a full 12 month period.

Who needs to create a profit and loss account

Limited Companies must produce a formal profit and loss account every year and submit it to HMRC. It's used to calculate the amount of corporation tax the company needs to pay.

If you're a sole trader or partnership, you don’t need to create a profit and loss account or tax purposes but it's useful to do one anyway so you can measure and compare business performance over a number of years.  You are likely to need profit and loss accounts if you're applying for a mortgage, taking out a loan, or seeking other finance for your business.

Keep a record of all your income

Business income falls into two categories for profit and loss reporting:

Sales income

The amount of money you earn from selling your goods or services in a trading year is your 'turnover', and it's the starting point for your profit and loss account. Keep a record of all your sales in one place.  You need to keep:

• Copies of sales invoices issued by you
• Rolls of till receipts
• Paying-in slips
• Bank statements
• Records for cash payments

Other income

Keep a record of any income your business gets from other sources, such as:

• Interest on investments or bank credit balances
• Sale of equipment you no longer need
• Rental income
• For limited companies – any money you personally invest in the business

Keep a record of all your costs

Keep records of everything you spend, including day-to-day expenses and equipment, plus anything you take out of your business for personal use.  Record the information so you're able to cross-reference it to your expenditure figures if asked.  Expenditure that does not have a receipt must still be logged with the rest of your spending so there is a record of it. You should keep:

• Copies of supplier invoices/receipts
• Till receipts for items bought over the counter
• Payroll and National Insurance records if you have employees
• Cheque book stubs
• Bank statements
• Credit card statements and receipts

Business costs and your profit and loss account

Your business expenditure is classified into 3 key areas for the purpose of reporting your profit or loss:

'Cost of sales' or 'direct costs'

These costs vary in direct proportion to the amount of goods or services sold, for example:

• Any sales commission you pay to your staff
• Stock bought for resale
• Components and raw materials
• Labour costs to create or manufacture the product
• Production costs

Cost of sales does not usually apply if you supply a service only.

Your sales income minus your cost of sales = your GROSS PROFIT

Your GROSS PROFIT MARGIN is your gross profit ÷ total sales revenue

'Fixed costs' or 'indirect costs'

These are all the ongoing expenses associated with running your business and are known as indirect or fixed costs as they do not vary according to the amount of sales you make, for example:

• Employee wages
• Rent or mortgage payments
• Rates
• General administration
• Marketing activity
• Interest on loans

Your gross profit minus your fixed costs = your OPERATING PROFIT

Your OPERATING PROFIT MARGIN is your operating profit ÷ total sales revenue

'Capital expenses'

If you've purchased or leased expensive items that contribute to the profits of your business they're called "capital items" or "fixed assets".  Some example of these might include:

• Equipment
• Machinery
• Tools
• Vehicles
• Computer equipment

There is some flexibility and judgement in calculating a profit and loss account, such as how long these fixed assets should be depreciated over, and what adjustments you should make to cater for bad debts. A qualified accountant will advise you what's reasonable and acceptable.

Free sample profit and loss account templates

Free profit and loss account templates are available from the Microsoft Office Online website.