A company’s profit & loss account is a record of all transactions that took place over the previous 12 months, and shows whether or not the business made a profit during the period in question.
Alongside the company’s balance sheet, the P&L account forms part of a company’s annual accounts package which must be submitted to Companies House and HMRC each year.
How company profits are calculated
Although your accountant will most likely create your accounts for your company, the fundamental steps in calculating the P&L are:
- You start with the company’s turnover for the year.
- Subtract the direct cost of sales for the period to provide the Gross Profit.
- Subtract all other business costs over the period to provide the Operating Profit.
- Account for any non-operating items, such as interest paid on loans.
- Corporation Tax is calculated on the Operating Profit figure, after deducting non-operating items (such as interest paid on loans).
- Subtract dividends distributed from post-tax Profits to provide the Retained Profit for the period.
Please note: these really are the most basic steps involved for illustrative purposes. What’s included in a P&L account will vary from business to business, and according to how an accountant sets out the figures.
What is a P&L account used for?
- The P&L calculates the profitability of a business, although it doesn’t show how a company has earned or spent its funds.
- One of the main uses of a P&L is to work out how much Corporation Tax a company owes for a given year.
- Larger companies will often use monthly P&L’s, but smaller ones will typically just produce an annual P&L to comply with their statutory reporting obligations.
- A company’s assets and liabilities are not shown on the P&L, but are contained in the company balance sheet.
- The P&L is used to determine the amount of dividends that can be distributed to shareholders. Dividends can only be paid out of post-tax profits, otherwise they are ‘illegal’. Read our guide to illegal dividends.