Tax & admin 3 January 2017

What is a profit and loss account? A small business guide

accounting
A profit and loss account reveals the amounts of money coming in and out of a business

Understanding profit and loss account documents should be a top priority for any new business owner. Here, recovery and insolvency expert Keith Tully explains what readers most need to know about this vital aspect of accounting.

In the simplest terms, a profit and loss account is a financial document that records and reveals the details of amounts of money coming in and heading out of a business during a specific time period.

Typically, a profit and loss account document will be used to illustrate how a business or a particular aspect of a business is performing financially over the course of a year, or over a three-month or six-month period.

There is almost always a lot that can be gleaned from the details of a profit and loss account sheet, but the key figures will be those that demonstrate how sizable your company’s profits or losses have been during the specified period.

Profitability is a very obvious goal to strive towards for a company of any size, and a profit and loss account sheet can help highlight precisely where your profits are coming from as a business, and how substantial they’ve been.

On the other hand, if your company has been losing money then a profit and loss account document can pinpoint why that’s the case and where your losses are being suffered.

Doing more of what works

A key part of the reason why a profit and loss document can be so useful for business purposes is simply that it can serve to illustrate where a particular enterprise has been most successful.

Success in business terms might not always mean maximising profits. For any number of reasons, it could be that generating revenue is more of a priority during a given period but there is often much to recommend an approach based on a strategy of essentially doing more of whatever activities are the most reliably profitable.

Cash flow demands can present their own issues and make it difficult to allocate resources in a precisely optimal fashion but having clarity about which activities are the most profitable within your business can be vital.

Similarly, being able to identify with precision which activities lead to losses or which don’t generate as much profit as you’d hope can be enormously helpful when it comes to planning for the future as a business boss in any industry.

Turning things around

Profit and loss accounts can also be useful if you’re in a difficult financial position as a business and there is a threat to your sustainability and viability going forward.

In moments such as these, there is a clear imperative to establish what the core aspects of your operations really are or ought to be and where your unsustainable losses are coming from.

No business boss wants to be faced with the kind of financial problems that might lead to insolvency or an unsustainable enterprise scenario, but if this is the reality then your profit and loss account can tell a crucially important story.

The key is to act fast and decisively in the interests of preserving what works and is most reliably profitable and essentially doing away with everything else, and certainly any elements which are clearly contributing to your organisation’s losses.

Understanding your options

Whatever your circumstances are as a business, whether you are concerned about your financial flexibility or in a position to invest strategically for the future, it can be helpful to understand what kind of financing options are or could be available to you.

There are an increasingly broad variety of financing solutions available to small or medium-scale businesses in the UK via non-traditional service providers.

So, once you’ve got to grips with your profit and loss account, a worthwhile next step could be determining what type of funding or borrowing options could help you shore up your company’s finances and prepare proactively for the future.

Keith Tully is a business insolvency expert and a partner at Real Business Rescue.

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