Business Basics: Profit & Loss

Profit and Loss

What is a Profit & Loss Statement? A profit and loss statement shows how much your business has earned and spent over a specified time. Sometimes referred to as an Income Statement or a Statement of Financial Performance – it records the businesses performance over a month, quarter, part or full year.

It shows whether your business has made a profit or loss during that time — hence the name.

The Profit & Loss Statement records your income and expenses over the time frame, matching your relevant costs to the income generated.

If you sell products rather than services a key measure on your profit and loss report will be Gross Profit. This is a measure of profit after matching your direct costs to your sales – for example if you purchase 1,000 items for $50 each but only sell half of them for $100 each, your income will be $50,000, and your cost of sales will be $25,000. The other $25,000 of items purchased will be treated as stock on hand in the Balance Sheet.

One of Three Financial Statements

A Profit & Loss Statement is one of three financial statements that every business needs to monitor regularly, along with the Cash Flow Statement and Balance Sheet.

Profit & Loss Statement - a view of operational performance, what we have sold less the costs of doing so.

Cash Flow Statementwhat money we have received and what we have spent
Balance Sheet – What we own and what we owe.

1. The Role of Time

A major difference between the Profit & Loss Statement and Cash Flow Statement versus the Balance Sheet involves their respective treatments of time.

The Profit & Loss Statement and Cash Flow Statement records transactions during a set period of time. The length of the period of time covered in the P&L statement may vary, but common intervals include quarterly and annually.

The Balance Sheet summarises the financial position of a company at one specific point in time.

2. Different Purposes

The P&L statement answers the specific question: "Is the business profitable?"By monitoring the P&L statement closely you will be able to identify where revenue is strong and where expenses are incurred.

The opposite is also true. For example, a company may notice increasing sales but decreasing profits and it can then search for new solutions to reduce its costs of operation.

A balance sheet is more specific.

A balance sheet reveals what a company owns or owes as well at a point in time. Unlike a Profit & Loss Statement the full value of long-term investments or debts appear on the balance sheet.

The balance sheet gets its name from the way that the three major accounts (assets, liabilities and shareholder's equity) balance out.

3. Profit Versus Total Value

Simply put, the P&L statement shows whether or not a company is in the red or black. The balance sheet shows how much a company is actually worth (or its total value).

It is also important to understand that the trial balance is different to a balance sheet. Read our blog "Business Basics: Trial Balance" for more information on what a trial balance is and how it is different to a balance sheet.

Comparing P&L Statements

Comparing profit and loss statements from different periods is important as the changes in revenues and operational costs, spending and net earnings over time can tell a more complete story.

For example, it is possible for a company's revenues to grow but its expenses might be growing at a faster rate.

Business owners can use the profit and loss statement to calculate several figures, including the gross profit margin, the operating profit margin, net profit margin and the operating ratio.

Along with the balance sheet and cash-flow statement, the Profit & Loss Statement provides an in-depth look at a company's financial performance.

Engine Room Chartered Accountants Tauranga & Pukekohe

If you're noticing that your numbers no longer fit or if you're spending too much time on your bookkeeping responsibilities then contact the team at Engine Room Chartered Accountants.

At Engine Room we are an enthusiastic group of chartered accountants that are dedicated to helping business owners (whether big, small or in the start-up phase) understand their numbers, grow profits and provide a roadmap to success so they can achieve their goals faster.

Call us on 09 238 5939 for our Auckland office, 07 579 5011 for our Tauranga office, or free phone 0800 236 446 for a no obligation chat.