Understand a profit and loss sheet

At its most basic, a profit and loss sheet is a good way to keep on top of your business's finances and the health of your business - and if your business is a limited company or a partnership whose members are shareholders, you're legally obliged to produce one once a year. But it has other very useful functions too.  This guide introduces you to:

  • What a profit and loss sheet is
  • What it's useful for
  • How to create it

What profit and loss sheets are

A profit and loss sheet shows, quite simply, whether you have made a profit or a loss in a given period of time - usually over a year. To get to the final figure, you deduct total expenditure from total income. It typically includes your gross income (excluding VAT), net income, gross profit, operating profit and profit before tax, then deducts from these, respectively, discounts and allowances, cost of sales, overheads, other income and deducts tax from profit.

What it's useful for

HMRC use most of the information on your sheet to work out your annual tax bill.  From your point of view, as well as helping you keep on top of your finances, a profit and loss sheet is used for showing how the business is doing to the people who need to know - owners, investors or potential investors, shareholders and banks. It's one of the first things they ask to see. It also helps you forecast your cash flow and profits, and plan future strategies.

How to create it

You can lay out your profit and loss sheet manually on paper, although using a computer spreadsheet is probably more reliable and much easier to update. You may want to use basic accounting software, which lays everything out for you.

You then total each of the following amounts:

  • gross income minus discounts and allowances,
  • net income minus cost of sales,
  • gross profit minus overheads,
  • operating profit plus further income,
  • profit before tax 

Lay each item out in separate columns, including separate columns for each amount that you deduct or add. Then total all of them to get your net profit or net loss. If you are VAT registered, you need to account for VAT - speak with HMRC about how to do this as they can provide you with the documentation.

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