Understanding the Profit and Loss

Being really clear on what goes into each of the main accounting reports is very important for a business owner. Apart from being a fundamental business skill, it will help you to really understand what is going on in your business, help you to see if something is wrong with the book keeping, and help you understand what your accountant does at year end.

Every single transaction in your accounts has to be coded to either the profit and loss, or balance sheet, so your book keeper needs to have a good understanding to make sure they code them to the right place.

What is the Profit and Loss?

The purpose of the profit and loss account is to measure how much profit was made in any given time period. This could be a month, a quarter, a year or any other time period. The important thing is that it measures all of the income made in that time, and all of the costs that directly relate to that income. This means that costs must be matched to a time period so we can get an accurate picture of how much profit your business generates.

If your income and costs don’t directly match then you’ll never know how much profit you make, which is very dangerous for your business.

We can liken the profit and loss to your personal monthly income and outgoings:

Salary income, less your monthly payments out like mortgage, bills, food, petrol etc. What you’re left with is your “profit”

Things that do NOT go into the profit and loss include:

  • Buying new assets
  • Getting a loan
  • Repaying loans
  • Paying VAT
  • Paying corporation tax
  • Directors loan transactions
  • Paying PAYE