Last editedOct 20202 min read
The balance sheet, cash flow statement, and profit and loss statement are three of the most important financial documents that businesses need to produce. The importance of the first two is already well understood, but how much do you know about profit and loss statements? Find out everything you need to know about this important financial document, right here.
Profit and loss accounts explained
So, what is a profit and loss account? A profit and loss account (also referred to as P&L or a profit and loss statement) provides you with an overview of your company’s revenue and expenses over a given period of time. These figures will show you whether your business made a profit or loss over that period (usually either one months or consolidated months over the course of a year). As a result, it’s one of the most important financial documents your business will need to produce.
What is a profit and loss statement used for?
Profit and loss statements provide you with insight into the financial health of your business over a period of time. That’s what sets it apart from your balance sheet, which only represents your finances at a particular moment. It’s important to compare your profit and loss statements across different accounting periods, as this can provide you with visibility into changes in operating costs, revenue, and net earnings over time.
P&L management is also a key part of calculating a couple of important financial metrics, including gross profit margin, net profit margin, and operating profit margin, providing you with an even greater insight into your company’s finances.
Why is it important to understand profit?
Profit is a great lens through which to understand the financial health of your business. If you have a significant amount of capital going in and out of your business, it’s not always easy to determine whether you’re actually making money. A profit and loss account can help you understand this in a little more depth. If you are making a profit, you can take the next step with your business – whether that’s expanding into new premises, employing more staff, or attracting further investment – safe in the knowledge that your company is financially sound.
What are the limitations of profit and loss accounts?
Although P&L management provides an excellent insight into your business’s profitability, there are a number of things that it simply won’t be able to tell you about your business. For example, a profit and loss statement can’t provide you with visibility into whether your business is running out of cash as you build stock. That’s why it’s so important to produce a balance sheet and cash flow statement alongside your profit and loss account.
How do profit and loss statements work?
All profit and loss statements follow a general form. They begin with an entry for revenue. This is also referred to as the “top line”. Then, the cost of doing business (including operating expenses, tax expenses, interest expenses, and the cost of goods sold) is subtracted from revenue. The difference (“bottom line”) produces net income, also known as profit. If you search online, you can find a broad range of profit and loss statement templates and examples that you can use for your own business.
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