Thinking of setting up your own business? There are all sorts of financial documents you’ll need to issue throughout the year – and one of those is a profit and loss statement. But what is it, and how does it work?
A profit and loss guide is the cornerstone of accounting for any small business. It details the expenditure of your business along with its income so you can arrive at an accurate bottom line for profit or loss.
The profit and loss guide serves as an important document for working out your tax liabilities and to back up applications for bank finance if you ever need it, so it’s crucial to keep it up to date and as detailed as possible. Perhaps most importantly, it is also a legal requirement for incorporated companies.
It sounds simple enough, but many business owners have to spend too much time running their businesses to keep on top of the administration. This can be a costly mistake.
Accountants suggest that any small business owner keeps a simple record outlining their expenditure and income. This should be split into different categories to make things easier for when it comes to handing information and documents to your accountant or to the HMRC.
Paul Chillman of TaxAssist says most businesses keep basic records but leave it to their accountants to get their profit and loss statement into proper shape at the end of the tax year.
“It’s a little more complicated than it sounds,” he says. “For example, there are different classifications of expenditure, so if you bought a new car or a computer it doesn’t necessarily come off your bottom line profit. Such items are capital expenditure, which is subject to depreciation and that takes some more complex calculations that spread the cost of the item over the course of its useful life. But that is really for your accountant to work out. As a rule, business owners should be keeping as close a record as possible on all income and outgoings so at the very least their accountants job is made easier.”
Chillman suggests using simple online tools to make the job easier and give you a format for inputting your income and outgoings. You should log the costs in to categories – such as stationery, insurance, rent etc – rather than itemising every single expenditure ad hoc. That way, you can keep abreast of expenses in different areas of the business.
Some companies will only produce one profit and loss statement per year; others produce quarterly statements which help them keep a tight rein over their business and micro-manage their expenditure – making adjustments to their business activities as they deem necessary. This is considered best practice but not compulsory.
As well as being important for assessing profitability and tax liabilities, profit and loss statements are also crucial if you ever need finance from a bank. They enable a finance company to see the trajectory of your business and how efficiently it operates. A profit and loss guide can really help here.
It’s important to remember that, when it comes to finishing your profit and loss statement, you should include money that is due to you in the income section – even if you haven’t received it yet. Similarly, any expenses that you have incurred but not yet paid – such as paying a supplier for goods not yet received – should also be included in outgoings.
As Chillman explains: “The bottom line is, the more detailed your profit and loss statement, the better.”
To see how online accounting software can help you track profit and loss, cash flow and your balance sheet, sign up for a free trial with QuickBooks.