Why profit and loss statements are important
Along with your balance sheet, your profit and loss statement (P&L) is the most significant financial document your business will produce. It’s sometimes referred to as an ‘income and expenditure account’ or a ‘statement of financial performance.’
With modern accounting software, you can produce P&Ls at the click of a button.
Your P&L is closely related to your balance sheet, so we recommend reading our article about understanding your balance sheet along with this guide.
Why your business needs a P&L
The main purpose of your P&L is to list all your income and expenses, and the difference between the two. That’s your profit or loss – and how you know whether your business is on track.
Your P&L usually shows the figures for this year and last, so it’s a great way to compare performance over time.
Frequency
Every business produces a P&L (and a balance sheet) at least once a year for their annual tax return. However, producing quarterly or even monthly P&Ls can help you spot trends and take action to address them earlier. For example, you may notice that certain expense items have increased significantly since the previous P&L.
What’s included
The P&L is accrual based, not cash based. That means it includes all your income and expenses for the period, whether a payment has been made/received or not.
For example, if you’ve invoiced for goods sold but haven’t been paid for them yet, they’re still included on the P&L. This provides a more holistic picture of how your business is performing.
The P&L should also include:
- Interest on any business loans (since this is an expense item)
- Depreciation on capital items.
What’s not included
A P&L doesn’t include:
- Any personal items
- Any capital items
- Any loans or repayment of the loan principal (the capital portion of the loan).
Example profit and loss statement
Now that we know the basics, here’s a typical example of how a P&L should be structured:
Acme Furniture Company Ltd
Profit and Loss Account: 2023 Tax Year
2022 | 2023 | |
|---|---|---|
Sales | $190,000 | $135,000 |
Less: Cost of Sales | - | - |
Production expenses | $35,000 | $25,000 |
Postage and packaging | $3,500 | $2,000 |
Total cost of sales | $38,500 | $27,000 |
Gross profit | $151,500 | $108,000 |
Other income | $2,500 | $570 |
Interest received | $1,250 | $895 |
Gross income | $155,250 | $109,465 |
Less: Expenses | - | - |
Accountancy fees | $1,250 | $1,190 |
Bad debts | $500 | $250 |
Electricity | $1,200 | $1,180 |
Telephone | $1,450 | $1,400 |
Vehicle expenses | $7,500 | $4,650 |
Office expenses | $12,560 | $12,200 |
Depreciation | $3,245 | $3,680 |
Shareholders salaries | $60,000 | $55,000 |
Total expenses | $87,705 | $79,550 |
Net profit (before tax) | $67,545 | $29,915 |
Understanding the expenses on your P&L
Two lots of expenses are deducted from the income of the business: the direct costs of producing your goods or services (also known as cost of sales or cost of goods sold), and the fixed expenses (or overheads) of running your business.
To understand more about why these expense categories are separated, and how to categorise them for your business, see our guide to understanding direct and fixed costs.
What you can learn about your business
The purpose of financial statements is to help you manage your business more effectively. Here is some of the key useful information your P&L gives you.
Gross profit margin
This ratio shows whether your average mark-up is sufficient to cover all expenses and show a profit. You can work this out using our gross profit margin calculator.
Expenses to sales ratio
This tells you if your expenses are increasing out of proportion to any growth in your business.
Using your P&L for analysis
There are a number of other ways you can analyse the information in your P&L. For example:
- You can look at the ratio of wages to sales to see whether wages are increasing or decreasing in proportion to any increase in sales. If wages are increasing faster than sales, you may need to take action to either increase your sales or reduce your wage bill.
- You can also pick any particular expense that you wish to monitor, such as advertising to sales. This ratio would enable you to measure the effectiveness of your marketing.
For more about using ratios to check the health of your business, see our article Checking the financial health of your business.
How to prepare your financial statements
Learn about the two main financial statements for your business: the Balance Sheet and the Profit and Loss Statement, and how to calculate some key finance ratios like profitability, business efficiency, or business liquidity ratios.
Contact an ANZ Business Specialist
Our specialists understand your kind of business and the challenges you face as a business owner. We can help you figure out how to make your business grow and succeed.
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