WHAT TECH FOUNDERS SHOULD KNOW ABOUT PROFIT AND LOSS ACCOUNTS

One of the most common questions that new tech founders ask is ‘What are profit and loss accounts?’ These vital business statements give company owners information about the financial health of the organisation as well as insight into exactly where money is being made and spent.

How do profit and loss accounts work?

You can use a profit and loss account (also known as a P&L or profit and loss statement) to track your company's revenue and expenses. These figures will tell you whether your business made a profit or loss during that period (usually one month or consolidated months over a year). Consequently, it is one of the most relevant financial documents for your business.

Using profit and loss statements, you can get an overview of your business's financial health. That's what distinguishes it from your balance sheet, which only shows your current financial situation. Comparing profit and loss statements across different accounting periods can provide insight into how operating costs, revenue, and net earnings have changed over time.

As part of P&L management, you can also calculate gross profit margin, net profit margin, and operating profit margin, giving you an even better picture of your company's finances.

Why is it important to understand profit?

Profit is a great lens through which to understand the financial health of your business. If you have a significant amount of capital going in and out of your business, it’s not always easy to determine whether you’re actually making money. A profit and loss account can help you understand this in a little more depth. If you are making a profit, you can take the next step with your business – whether that’s expanding into new premises, employing more staff, or attracting further investment – safe in the knowledge that your company is financially sound.

Profit is a great indicator of the health of your business's finances. Having a significant amount of capital flowing into and out of your business makes it difficult to determine whether you are making money. Profit and loss accounts can help you understand this better. Having made a profit means you can take the next step with your business, whether it's expanding into new premises, hiring more staff, or attracting additional investment.

What are the limitations of profit and loss accounts?

Despite the fact that P&L management provides valuable insight into your business's profitability, it won't be able to tell you everything about it. A profit and loss statement, for example, cannot show you whether your business is running out of cash as you build inventory. In addition to your profit and loss account, it's vital to prepare a balance sheet and cash flow statement.

How do profit and loss statements work?

Profit and loss statements follow a general format. The first entry is for revenue. Also known as the "top line". Revenue is then subtracted from operating expenses, tax expenses, interest expenses, and cost of goods sold. Net income, or profit, is the difference ("bottom line"). Online, you can find many profit and loss statement templates and examples that you can use for your own company.

At least once a month, business owners should review their profit and loss account statement to understand their current position. Income statements can be very simple, such as the following:

Or you might want to break it down a bit more to understand your core operating gross and net profits:

If you would like to find out more about understanding your Profit and Loss accounts, contact Suzy Kerton today on 0203 468 2241