Profit and loss accounts or income statements are useful documents that allow you to see how well a business is doing. This is handy when you are deciding whether or not to purchase or invest in a business and also useful because you can see how your business is faring. Unfortunately most people are not sure what they should be looking for and this severely reduces the usefulness of these documents.
Normally the profit and loss account contains information that covers one year of the company’s trading. This information consists of turnover, sales, costs and how much profit has been made. I will be going over which figures to look for in this blog and what they could mean for a business.
Turnover
This is the amount of money generated in the business through sales. While a small figure means not much money has come into the business, a larger figure does not necessarily mean the company is doing well as costs haven’t been deducted yet. Turnover should never be a negative figure.
Direct Costs
These costs are related to and often dependant on the turnover of the business. This can be items bought for resale, or materials and subcontractors for carrying out services. This figure will also take any stock held into account. Direct costs should be lower than the turnover; the bigger the gap the better.
Gross Profit
This figure is the amount of money left over once you have subtracted your direct costs from turnover. Some types of business will have a high gross profit due to low direct costs and vice versa. If the gross profit is a negative figure the company has a major problem; it means you would be losing money on each individual sale.
You can calculate the gross profit as a percentage of the turnover and this should stay roughly the same each year. If there are any major fluctuations in the percentage of gross profit to turnover, it would be worth investigating.
Operating Costs
These are the costs of running the business. Operating costs will be roughly the same regardless of your turnover, with the exception of any large changes due to business expansion or reduction.
In the early years of a business this figure can seem high due to you having the costs while you are trying to grow the business. If there is a large change in the operating costs over the years it may be worth finding out why.
Net Profit/Loss
This is the leftover money that has come into the business once you have taken all of the expenses out of the turnover. Unlike gross profit this figure can be negative and not necessarily mean there is a problem. Often in the first year of trading a business will have a negative net profit (or net loss) and you can have a bad year of trading. If this is a large positive figure, then you know the business is doing really well.
Other Figures
Below the net profit/loss you will normally have the amount of tax due if the business has made a profit. Even though the net profit figure is available to be taken out, it is a good idea to ensure you have enough money leftover to pay the tax.
For limited companies, you will often get a dividends figure. This figure is for profit being drawn out of a company and given to its shareholders as a dividend. If you divide this number by the number of shares in the company you will get the amount of money each shareholder was given in that accounting year.
You will also get a figure for profit leftover after tax and dividends. For a sole trader business, this is the money left that you can spend how you wish. For a limited company, this is the amount of profit that is carried forward into the next year and will be followed by the amount of profit for preceding years and the amount of profit carried forwards to next year.
If you would like any help or advice regarding the above, please do not hesitate to contact us.
