The profit and loss (P&L) account initially provides a forecasted plan of how a business will perform and then record of how a business has performed over what is usually twelve months for formal accounts and one month for management accounts. It provides a ‘snapshot’ summary of the total sales income (Sometimes referred to as turnover or revenue) and allowable expenses. It is designed to establish on paper if the business is likely to be viable in creating enough profit to cover the business owner’s personal survival budget and pay any taxes that might be forecasted. The actual figures will establish the tax bill.
How the P&L works?
• The sales income for a specific period from products or services as well as other sources of income, including the sale of business assets and bank interest received.
• The allowable business expenses for the period. This includes the costs associated with sales as well as all other business expenses.
• The profit or loss achieved in the period.
Some accounting terminology
This is the income from the sales of products or services during the period shown in the P&L account (excluding VAT if the business is VAT-registered). An invoiced sale is included as a sale regardless to whether the payment has been received.
Cost of sales
Cost of sales, also known as direct or variable costs, are the costs that can be directly attributed to the production of a particular product or sale of an item. The costs could be materials used and staff costs directly used.
This is the difference between sales turnover and the cost of the direct sales.
This covers all operating costs that are not linked directly to producing a product. They could include rent, utilities, insurance, marketing, stationery, loan interest and staff costs not recorded under cost of sales. They are generally regarded as fixed costs because they do not rise or fall in direct proportion to your output.
This is also referred to as ‘profit before interest and tax’. It is the profit generated after all normal operating expenses have been deducted.
This is also referred to as ‘profit after tax’. It can either be distributed between the owners of the business or retained and used to fund further growth.
Getting value from your P&L
This can be monitored by reviewing the P&L account regularly (preferably once a month), together with the balance sheet and cash book, which records all the money coming in and out of the business. It is also useful to produce a forecast P&L for each year and, ideally, each month. This will help to compare the actual figures the business achieves against the forecast.
By comparing the two sets of figures, it is possible to identify what has gone well, such as achieving higher sales, or what might need more attention, such as coping with increased costs. Working through the P&L process allows changes that need to be made to be identified and corrective action to be taken as soon as possible. Comparing the performance of the business in the current year against the previous year provides a useful benchmark in demonstrating the progress of the business. It is important to factor in any relevant industry or market trends to get the fullest picture.
Ten P&L tips on improving margins
1. Are you targeting the most profitable work rather than doing what you have always done? Some businesses do not review closely the type of work undertaken in relation to how profitable the work is
2. Are you reviewing your suppliers? Organise time in your diary to review suppliers. Note any contractual periods to ensure you make time to consider alternative suppliers before renewing
3. Look at your processes – Are you working effectively and efficiently and therefore avoiding unnecessary lose of time, duplication, reoccurring mistakes, inadequate use of technology etc
4. Are you reviewing your price structure? – You may not be charging enough in relation to increases in your costs, market value or in comparison to your competition?
5. Are you up selling and/or cross selling? – Both potentially allow you to make more profit from each transaction. Examples are selling a double burger rather than a burger or selling a drink with a burger.
6. Can you increase you sales conversion rate? – Research and analyse why you might miss out on sales.
7. How good are you in communicating and building relationships? Selling to existing customers costs less than attempting to find new customers –
8. Are you proactively increasing customers referrals? – It is not good enough to simply do a great job and hope that you are referred.
9. Are you skilled in marketing, selling and negotiation? – Consider your continued professional development
10. Buy low, sell high!