A Profit & Loss Account (P&L) shows whether a profit or loss has been made on the sales income of an organisation after deducting costs. Therefore, it shows the financial performance of a company.
It is important to note that the P&L does not care when cash is paid or received. When a sales invoice has been raised, this is shown in the Sales line of the P&L. However, the money for that invoice is received 30 days later (if the customer is not late in paying!) assuming typical terms and conditions in the UK. Similarly, when a purchase invoice is received from a supplier and entered onto the accounting system, this then shows as a cost in the P&L, even though it may take 30 days to physically pay this invoice.
Why is this distinction so important? Because a company can look profitable but may not have any cash in the bank and therefore go bust. A business could have raised lots of sales invoices, look really profitable but simply not be receiving the money in a timely manner from its customers. That’s why it is critical to not just read the P&L in isolation of the other primary financial statements – the cash flow statement and the balance sheet.
A very simple Profit & Loss Account would look like this:
|P&L Category||Amount £’000s||Notes|
|Sales / Income||100||Sales invoices raised (NOT cash!!!)|
|Less: Direct Costs||(40)||Costs directly linked to the sales made|
|Gross Profit||60||Sales less direct costs|
|Add: Other Income||5||Income that isn’t the main trade of the business, e.g. your company sells business cards (main trade) but also rents office space (Other Income)|
|Less: Overheads||(50)||All the costs of the business incurred regardless of whether make any sales, e.g. salaries, rent, etc.|
|Pre-Tax Profit||15||Profit or loss made on sales after all above costs taken into account|
It is worth noting that not everything a company spends its money on is shown in the Profit & Loss Account! Assets that an organisation buys, such as motor vehicles, IT hardware and software and office furniture all appear on the Balance Sheet – more on that in a future blog.
As long as you remember that the Profit & Loss Account is NOT cash, then you will be reading and interpreting it better than most!
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