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FINANCIAL LITERACY •  23 JULY 2021 • 2 MIN READ

What exactly is a profit and loss account?

What exactly is a profit and loss account?

Before we say anything – let’s establish that a profit and loss account is known by a few other names:

  • Income statement
  • P&L statement
  • Statement of income

It’s one of the critical financial statements that every business must prepare at the end of each financial year to assess financial health and calculate taxable income. Collectively, these financial statements cover assets, liabilities, revenue and expenses. Whereas the balance sheet covers the asset and liability components, the profit and loss account handles revenue and expenses.

What makes a profit and loss account the most useful financial statement?

By reporting on income and expenses, the statement calculates a business’s net profit.

In addition, it breaks down income and expenses to a granular level. Accountants and business owners can use these details to identify opportunities for optimisation. They’re able to analyse:

  • The cost of sales (or manufacturing expenses)
  • Operating expenses
  • Non-deductible expenses
  • Financial expenses
  • Selling and administration expenses
  • Non-cash expenses

Who uses a profit and loss account?

A range of users are interested in the profit and loss account. It’s important that they check it alongside the balance sheet to make sure the business has cash and positive equity.

Those interested in your profit and loss account include:

  • Accountants – when preparing an income tax return
  • Banks – to see whether the business is making enough profit to repay a loan and interest
  • Potential investors – checking how profitable the business is
  • Shareholders or potential investors looking at companies listed on the stock exchange – will the company declare a dividend from its profits?
  • Management – comparing the actual figures against their budget
  • Business owners – investigating unusually high expenses and also forming their budget for the coming years

Our next article takes a deeper look at the profit and loss account

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