Profit and loss statement – Explained

A profit and loss statement explained so that if you are new to business you can understand how this works.

The basics of a Profit and Loss Statement is that the report begins with “Total Sales” disclosed net of Value Added Tax (VAT). The next figure to appear on the report is Cost of Sales or in other words, the amount that it cost you directly to make the “Total Sales” in the period under review, net of VAT and net of opening and closing stock.

The resulting figure after deducting Cost of Sales from Total sales is the businesses Gross Profit and these figures are referred to as the “Top Line” – an example of the “Top Line” figures is, as follows:

 

XYZ Company Profit and Loss Statement for the period ended 30 April 2009
 
£
£
Total sales  
340,000
Cost of sales    
Opening stock
11,000
 
Purchases
120,000
 
Closing stock
(13,500)
 
 
_________
 
Cost of sales  
117,500
   
________
Gross profit  
222,500
   
======
Gross profit margin  
65%

In this example XYZ Company’s gross profit is £222,500 and the Gross Profit Margin is 65%, which is calculated as £222,500/£340,000 and means that for every £100 worth of product or services sold the business makes £65.

The company’s gross profit is the profit that goes towards paying the overheads and expenses of the business, so it is crucial that a business makes a gross profit otherwise the owners might as well shut up shop and go home. This might be like stating the obvious to some people, but believe it or not, in my time of consulting with businesses I have come across businesses that are making a gross loss and they wonder why they are in so much debt!

The second part of your Profit and Loss Statement is what is known as the bottom line figures, which includes the businesses overheads or expenses. The overheads include expenses such as employee wages, rent and rates, telephone charges, marketing and advertising costs, printing and stationery costs, bank charges and loan interest and so on.

The overheads are those expenses that arise whether or not the business makes any sales – so for example, where the business rents it premises the rent will need to be paid each month regardless of whether the company makes any sales or not. This is how these costs are distinguished from the businesses cost of sales, whereby the cost of sales are only incurred as the business makes sales and except for buying the initial stock, if no sales are made then the business will not make any purchases.

A further example of a profit and loss statement which includes overheads is shown below:

XYZ Company Profit and Loss Statement for the period ended 30 April 2009
 
£
£
Total sales  
340,000
Cost of sales    
Opening stock
11,000
 
Purchases
120,000
 
Closing stock
(13,500)
 
 
________
 
Cost of sales  
117,500
   
________
Gross profit  
222,500
Overheads*  
150,000
   
________
Net profit  
72,500
   
======
Net profit margin  
21.3%

* Normally the overheads would be split out to show each expense as a list, but for simplicity in this example I have amalgamated this figure into one total.

When you deduct the overheads from the Gross Profit you get the businesses Net Profit or if the overheads are in excess of the gross profit the business would be suffering a net loss. This is okay and is normally expected with a new business for the first year or so, until the sales are to a level that produces a high enough gross profit which exceeds the overheads.

The businesses Net Profit Margin in this example is 21.3% which is calculated as £72,500/£340,000. You should really be aiming at a Net Profit Margin of upward of 10% really, especially in a small business scenario. To learn how to improve your businesses Net Profit Margin you can take a look at the Profit Increase Software.

If you are new to business and need some help then by all means email me at info@in-business.org.uk and I will try to answer any questions you might have. Alternatively, you can visit my Business Forum and post your question there and join the business discussion.

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