Profit and Loss Account Basics

I Thought I would start this blog by giving you an explanantion of what the main financial statements are supposed to be telling you.

I will deal with the profit and loss account in this post.

The profit and loss account tells you quite simply, whether you have made a trading profit or loss for the period that you are reviewing. It summarises what sales you have made and deducts from them the expenditure incurred in making and servicing those sales.

Typical expenditure will be, cost of materials/inventory, packaging, delivery costs, promotional costs, administration costs such as office staff salaries, heating, lighting, stationery and so on. Every business will have its own regular costs.

Please note however that the costs shown in the profit and loss account are all items that are ‘consumed’ straight away. By this I mean that they are either used up immediately like delivery costs or electricity, as opposed to a cost for something that can be used over and over again; like a car or factory machinery.

These longer term costs are actually for assets of the business which you will find included in the Balance Sheet.

The profit and loss statement is prepared using one of the most fundamental principles of accounting. This dictates that sales will be matched against all the costs incurred in obtaining those sales.

Thus your accountant will make sure that he/she deducts any costs that you have incurred for materials, labour, packaging, delivery etc.

More than this though, your accountant will match these costs to the sales irrespective of when those costs were actually paid for. Thus even if you pay for costs late your accountant will include them in your profit and loss account. This is called accrued expenditure.

This is how the profit and loss is different from a simple cash flow, it is not simply a record of receipts and payments but attempts to show you whether your sales have been worth the effort financially.

From this you can deduce whether you have been effective in pricing your product and controlling your costs.