Most Financial Statements comprise of two standard reports, which are commonly known as the Balance Sheet and the Profit & Loss Statement.
In this article we’ll focus on the Profit & Loss Statement.
I’ll start this with an observation that it’s a misleading title – you’ve either made a profit or you’ve made a loss, you can’t make both in the one period. So why it’s called a Profit & Loss Statement is beyond me!
Accounting standards and practice are starting to move towards the title of Statement of Financial Performance, which seems much more appropriate. However I think that for the smaller business sector the traditional title will remain so we’ll use it here (abbreviated to P&L as most people do).
The P&L is a financial representation of the income/sales for a given period, less the expenses incurred in earning that income – with the bottom line being the Profit (or Loss) from activities for that period. As one of my clients calls it, the P&L is their “How are we going?” report.
The P&L can be prepared for whatever timeframe you want – a week, a month, a quarter, a year or even longer.
Within the P&L we can get into all sorts of wonderful detail determining what constitutes income and the expenses incurred in earning that income.
The three main components of the P&L are:
- Income for a given P&L should be the sale value of all goods or services provided to your customers in the period. If you are lucky enough to receive payment from a customer in, say June, but you do not hand over the goods until August, then the income is picked up in the following year.
Alternately if you provided the goods in June but the customer doesn’t pay you until August then the income is picked up in the earlier year.
- Expenses can be a bit trickier. Basic costs like wages, motor vehicle costs, printing and stationary, repairs and rent etc are easy enough.
If you hold stock or work in progress you need to adjust for the value of any unsold items at period end.
If the $ impact is large enough you’ll also need to include an estimate for the reduction in value of your fixed assets due to normal aging/wear and tear (on cars, equipment etc) – this is commonly called Depreciation.
Another common example is Employee Leave Entitlements. If all your staff worked for the full year and didn’t take any holidays you need to include an extra expense in the Trading Statement for the year recognising the fact that you have a future obligation to pay them the statutory four weeks annual leave. It may not be paid until a later year but the cost of that increase in Leave Entitlements relates to the sales in this year and needs to be recognised as such.
- The third key component is Income Tax is another expense item, even though it’s a bit different in the calculation basis. There can be complicated timing (and sometimes even so-called permanent) differences in determining what is the Income Tax Expense for a given period, compared to the actual amount you might have to pay for that period.
So that’s all the P&L is – a report showing the income generated in a specified period less all the expenses incurred in earning that income.
If you’d like some assistance interpreting your P&L, contact us.