It is important to the effective management of a business to track the profitability of the business over time. The idea of a P&L statement has been developed over 500 years to show business profitability and to allow managers to better understand the factors that affect the profitability of their business so that they can make informed changes in their business.
The P&L is also known as the ‘Income Statement’ especially in the USA.
The P&L is one of the three main accountancy reports that are used by business managers and analysts to understand the performance of a business. (the others are the Cashflow Statement and the Balance Sheet)
P&L statements can be requested by suppliers who want to evaluate the business as a credit risk when they provide payment terms or by banks who want to evaluate the business ability to re-pay a loan.
Creating a regular accurate P&L is one of the primary tasks of any accountancy package an eTail Support is designed to do it effectively and easily.
Every P&L statement should have a start data and an end date. The P&L statement tells you how the business has performed between the start and end dates – it can tell you nothing at all about what happened before the start date or what happened after the end date.
It is normal for a business to produce a regular P&L reports covering periods of the same length so that the business performance can be tracked over time. It is normal for retailers and fast moving businesses to work with weekly P&Ls, others prefer monthly and some very fast businesses track profitability on a daily basis. If you are a eTail Support customer we can help you to decide what is best for your business and to set up your reporting systems correctly – just get in touch with your account manager.
To help you to understand how your various costs affect your profitability a typical P&L is split up into sections as shown in the example below.
Section 1 Revenue #
The Revenue section shows the business revenue splitting the different type of revenue up so that you can see how they compare
Section 2 Cost of Goods Sold #
This section shows the costs that are directly attributable to those revenues, for example if the business sells products that it buys from a supplier, the cost of the items sold to customers in the recent line
Section 3 Gross Profit #
The Gross Profit of the business is the raw measure of its ability to sell product at a profit, it can be positive or negative, but a business with negative gross profit has very serious problems!
Gross Profit is calculated as Total Revenue minus Total Cost of Goods Sold
Section 4 Overheads #
Most businesses have lots of costs that are not directly related to the revenue that they make, for example the costs of Rent, Electricity, staff wages and other general running costs, these are referred to as overheads.
To make the P&L as accurate as possible you need to make sure that only the part of each expense that relates directly to the period that the P&L is reporting on, so for example if you have a weekly P&L for a business that rents its premises for $5,000 per year the weekly overheard for Rent will be 5,000/52 = 96. The process that sits behind the correct allocation of expenses to Reporting Periods is more complex than a simple division, it is called “Accrual”.
Section 5 Profit Before Interest Tax Depreciation and Amortisation (EBITDA) #
EBITDA is a really useful measure of the profitability of a business, it is usually very similar to the business cash flow and it is the same as Profit Before Tax for any business that is financed by its own cash and has no bank or other borrowings.
Section 6 Depreciation and Amortisation #
Depreciation and Amortisation are ways of spreading the cost of large assets like machinery or expensive pieces of technology over the whole life of the asset. In the same way that we considered only the relevant part of the rent in the Overheads section by depreciating a large machine tool each month we are able to allocate its cost more accurately to the business P&L.
Section 7 Profit before Tax #
Depreciation and Amortisation is deducted from EBITDA to calculate Profit before Tax
Section 8 Tax #
Most companies pay corporation tax and others may pay other taxes, they are recorded here
Section 9 Profit after Tax #
When you deduct the cost of Tax from Profit before Tax you (obviously!) get the Profit after Tax. The Profit after Tax is normally shown on the bottom line of the P&L and it represents the actual, spendable profit of the business which can be taken out by the owners or used by the business – hence the colloquial phrase for business profit – ‘the Bottom Line’
It is normal for the P&L of a UK business to ignore VAT as it does not affect profitability.