The Profit and Loss report shows your business’ sales and expense totals over a given period. It subtracts the associated costs from the sales, to show you what’s left as profit. The Profit and Loss report is sometimes called an Income Statement or Profit and Loss Statement.
Why is it important?
The Profit and Loss report shows if the business is making or losing money. It's typically reviewed by business owners, managers, or a board of directors to make business decisions. The business may also use the Profit and Loss report for taxes and finance applications, to present a view of the business to banks, investors, customers, and suppliers.
The report shows investors and lenders the profitability of your business over time. This allows them to evaluate whether your business can repay its loans and interest and to see how much income your business generates. A Profit and Loss report run for internal use may include more detail such as sales revenue sources and direct expense analysis. Stakeholders analyse the details to make informed decisions. For example, to approve or reject plans to open a new branch, close a department, or to adjust production levels.
What's on the report
The Sales section includes the balances of all nominal accounts in the Sales category. The nominal accounts in this category may vary depending on the business type:
- Product-based. You will see totals from the sale of goods
- Service-based. Shows totals from selling services to customers. For example, consultations or other hourly services
- Project-based. Revenue generated by one-time projects with existing and new customers. This type of business may have lines for transactional accounts as well as services
- Recurring. Earnings from the ongoing sale of goods, services or after-sale services provided to customers. Many businesses prefer recurring revenue models because they are predictable and assure that the source of revenue will remain the same over time. For example:
- Subscription fees
- Renting or leasing assets
- Licensing content to third parties
If you are creating a monthly report, it will include all sales income generated during the month. This includes both sales from both paid and outstanding invoices. Accounting in this way is called accrual accounting. The revenue generated in a three-month period will be added up if you chose to run a quarterly statement.
Direct Expenses, also called Cost of Sales, typically vary with changes in sales amounts and represent the cost of goods and services used to generate revenue. To deliver your product or service to your customers, you will almost always incur costs. Manufacturing a product, for example, will cost you money in raw materials and labour. The cost of purchasing a product from the manufacturer will have to be included when you sell a product. For example, you will spend money on food and staff if you own a restaurant.
Direct expenses for service-based businesses are usually lower than those for product-based businesses. However, as a service provider, you must account for the cost of your time or your employee's time. Other direct expenses are often incurred during the provision of the service, such as supplies.
Having calculated your Sales and Other Income, Direct Expenses are subtracted to arrive at your Gross Profit. Gross Profit is the money your business makes from the sale of your products or services. A loss is usually shown as a negative amount.
Percentage Profit (or % Profit, also known as Gross Profit Margin) is a measure of profitability that shows the percentage of sales that exceeds the direct expenses. Based on the costs involved in producing their products and services, % Profit reflects how successful a business is at generating revenue.
% Profit is calculated by subtracting the Direct Expenses total from the Total Sales and dividing the difference by the Total Sales. To calculate the Gross Profit Margin as a percentage, multiply the result by 100.
The higher the % Profit, the more efficient the business is at generating profits for every pound spent and, therefore, can identify inefficiencies and pricing issues. A higher percentage indicates that a business is producing its product more efficiently. The business may be compared to competitors or across time periods.
If a business produces its product inefficiently, its % Profit will be lower. This is determined by benchmarking the % Profit against companies in the same industry or if the % Profit is declining over time. A poor pricing strategy can also result in a low % Profit. An inadequate gross profit margin will prevent a business from covering its expenses and providing for future growth.
Overheads are also known as Expenses or Indirect Expenses. Unlike Direct Expenses, Overheads are not directly related to a specific cost object like a service or product. They are costs that are needed for the general running expenses of a business.
Expenses that are directly related to sales can be included in Direct Expenses, depending on how closely they are related to the sales generation.
The following are examples of overheads:
- Wages for non-sales employees
- Employee benefits
- Travel Costs
While you can see your business’ gross profit by subtracting the Direct Expense total from the Sales total, your Net Profit shows the profitability of your business. Net Profit is calculated by subtracting the Overheads total from the Gross Profit (Sales minus Direct Expenses) minus Overhead.
Because revenue may not always translate into profit, Net Profit is essential. Profits (positive results) mean your business is doing well financially, and future decisions can be geared towards further growing profitability.
If you have a negative Net Profit amount, your business has lost money. If this occurs, you might consider what improvements can be made, a different strategy, or where you can cut costs or increase revenue.
Taxes for your business are based on the net profit you make each year. As a result, the greater the profit, the greater the tax. Many businesses will look to reinvest their profits in the business before year-end. For example, they may look at increasing inventory, boosting marketing, or repaying debts.
The Net Profit Margin, shows as a percentage. It indicates how much Net Income was generated in relation to the Sales total. This percentage is calculated by dividing the Net Profit total by the Sales total and then multiplying it by 100.
Investors look at the business's Net Profit Margin to assess whether the business is generating enough profit from sales and if Direct Expenses and Overheads are well managed.
The Net Profit Margin is one of the indicators of the business's financial health. With larger profit margins, more of the sales is kept as profit.
Because taxes are paid on the Net Profit, business owners may want to track the Net Profit as a cumulative year-to-date value.
Category totals show as a percentage. They indicate how much each Individual Ledger Account contributes to the subsection that it falls under.
The percentage is calculated by dividing the Individual Ledger Account balance by the Total subsection.
This option is only available when "Show Accounts" has been selected as the calculation relates to each individual account.
What's not on the report
The following items are not included in the Profit and Loss report:
- Draft and proforma invoices
- Gratuities collected and paid
- Sales taxes
- Income taxes
- Payments and receipts
- Income such as grants or cash injected by the owners
- Purchases of significant equipment or assets
- Loans taken or repaid
- Owner drawings