The Profit and Loss Account

Geoff Leese Sept 1999 revised Sept

2001, Jan 2003, Jan 2006, Jan 2007,
Jan 2008, Dec 2008
(special thanks to Geoff Leese)

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 Profit and Loss Account
 A profit and loss account is a summary of business
transactions for a given period - normally 12 months.
By deducting total expenditure from total income, it
shows on the "bottom line" whether your business
made a profit or loss at the end of that period.

 A profit and loss account is produced primarily for

business purposes – to show owners, shareholders or
potential investors how the business is performing. But
most of the information is also used by the Inland
Revenue to work out your tax bill.

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 Trading Account

 That part of the profit and loss account

where the cost of goods sold is compared
with the money raised by their sale to
arrive at the gross profit
 This gives a view of the business in terms
of sales and viability of profit

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 Retail trading account for Nov

£ £
Sales 50 000
Opening stock 12 000
Purchases 30 000
42 000
Less closing stock 15 000
Cost goods of sold27 000
Gross profit 23 000

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 Yearly Profit and Loss
 By law, if your business is a limited company or a
partnership whose members are limited companies, you
must produce a profit and loss account for each financial
year
 Self employed sole traders and most partnerships don’t
need to create a formal profit and loss account - the
information they complete on the self assessment tax
return form amounts to the same thing
 However, there are key benefits to producing formal
accounts. If you are looking to grow your business, or
need a loan or mortgage, for example, most institutions
will ask to see three years’ accounts

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 Keeping accurate records
 By law business must keep accurate records of income and
expenditure. Keep self-employment records for five years and
limited company/partnership records for six years after the
latest date your tax return is due
 Accurate record keeping has important benefits. It:
 gives information to manage your business and make it grow
 enables reporting on profit/loss easily and quickly when required
 will improve your chances of getting a loan or mortgage
 makes filling in your tax return easier and quicker
 helps you or your company avoid paying too much tax
 provides back-up for claims for certain allowances
 helps you plan and budget for tax payments
 prevents interest or penalties for late tax payments
 helps reduce accountant fees - your annual accounts will be far easier to
produce

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 The basic records you will
need to keep are:
 a list of all your sales and other income
 a list of all your expenditure, including day-to-day
expenses and equipment
 a separate list for petty cash expenditure if relevant
 a record of goods taken for personal use and payments
to the business for these
 for limited companies: a record of money taken out for
personal use or paid in from personal funds
 back-up documents for all of the above
 You will need the information above to create your
profit and loss account

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 The Profit and Loss Account
The profit and loss statement shows the trading
performance of the business and the distribution
of profit. Profit is not equivalent to cash in bank
Income
Customer sales, profit/loss from sale of tangible fixed assets, “non
operating” income, investment income
Expenses
Variable (direct) costs, Fixed (overhead) costs, interest paid,
depreciation allowance on tangible fixed assets
Distribution
Drawings/dividends, retained profit

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 Profit and Loss account
Measuring profit
Income

Expenses

The profit and loss statement shows

the trading performance of the Net Profit
business and the distribution of
Drawings or
profit. dividends

Retained
Increase in assets
profit

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 Or measuring loss
Turnover

Costs

Net Loss

Drawings or
dividends

Retained
Decrease in assets
loss

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 SIMPLE COMPANY LTD - Profit and loss account for
year ending 31.12.08
£
Turnover 950,000
Cost of sales (Direct costs)
525,000 Trading account
Gross profit 425,000
Expenses (Overheads) 325,000
Other Costs (Depreciation) 10,000
Operating profit 90,000
Non-operating income 24,000 Profit and Loss
Interest payable 15,000
Profit on ordinary activities before Account
taxation/Net profit 99,000
Corporation tax 22,500
Profit after tax 76,500 Appropriation
Dividends 30,000 Account
Retained profit for the period 46,500

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 Cost of sales (Direct costs)
£ £
Production wages 110,000
Material costs
Opening stock 01.01.08 110,000
Plus purchases during the year 500,000
610,000
Less closing stock 31.12.08 195,000
415,000 415,000

Cost of Sales 525,000

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Expenses (overheads) £ £
Wages and salaries (admin) 140,500
Heating and lighting 35,500
Rent and rates 40,000
Telephone 10,000
Advertising 16,000
Car expenses 42,000
Printing and stationery 17,000
Accountant fee 5,000
Insurances 10,000
Provision for bad debts 9,000 325,000
Other Costs
Depreciation 10,000
335,000
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 Depreciation
 Fixed assets such as cars, computers, and machinery are not
treated the same as other expenses.
 Instead of being offset against revenue in the year of
purchase, a proportion of the purchase value is allowed as an
expense each year over the life of the asset.
 At the end of the useful life of the asset, it is disposed of
(scrapped or sold) and added into the P&L account as non
operating income

Typical example
Computer £ 1100, life of 3 years, expected to make
£50 at disposal
Depreciation (£1100-£50)/3 = £350 per year

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 Interest and charges
£ £

 Non-operating income
 Interest on bank accounts 24,000
 Other investment income 0
 24,000
 Interest payable
 Loan interest 12,000
 Overdraft charges 3,000
 15,000

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 Simple Home Trader P&L Account for year ending March 31st 2008

Consultancy fees £17,700

Overheads
Taxable
Depreciation £2150 amount for
Overdraft cost £80 inland
Car expenses £1500 revenue
Other transport £550 returns
Telephone £430
Stationary £700
Insurance £350 £5,760
Net Profit £11,940
Drawings £7,000
Net profit retained in business £4,940

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 Financial Ratios (Profitability)
Monitoring direct costs (manufacturing companies)
 Gross profit margin = Gross profit / sales
 Cost of materials (%) = materials costs / sales
 Cost of labour (%) = labour costs / sales
Monitoring overhead costs
 Net profit margin = Net profit / sales
 Overhead cost (%) = Overhead costs / sales

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 Simple Company Limited profit ratio analysis
Year 2008 2007 2006
 Turnover 950,000 800,000 700,000
 Cost of sales (Direct costs) 525,000 500,000 450,000
 Gross profit 425,000 300,000 250,000
 Expenses (Overheads) 325,000 200,000 150,000
 Other Costs (Depreciation) 10,000 12,000 15,000
 Operating profit 90,000 88,000 85,000
 Non-operating income 24,000 20,000 20,000
 Interest payable 15,000 16,000 17,000
 Profit on ordinary activities before
taxation/Net profit 99,000 92,000 88,000
 Corporation tax 22,500 20,000 18,000
 Profit after tax 76,500 72,000 70,000
 Dividends 30,000 28,000 30,000
 Retained profit for the period 46,500 44,000 40,000
 Gross profit margin 44.7% 37.5% 35.7%
 Overhead cost 34.2% 25% 21.4%
 Net profit margin 10.4% 11.5% 12.6%

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 Further Reading

 Dyson, J.R. (2001); Accounting for Non-accounting

Students (5th edn); Prentice-Hall (other editions exist)
 Chapter 3 (Covers book-keeping)
 Chapter 4 (Covers Profit and Loss and Balance Sheet)
 Chapter 5 (Covers adjustments)
 Chapter 6 (covers all of these in a company context)

A substantial amount of reading – some 100 pages in all.

But necessary.

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