Understanding the profit and loss account

Understanding the profit and loss account

Session one – the trading account

The goal of most people who set up a business is to make money. To earn a profit is to receive more money from sales than you are paying out for expenses. Profit is effectively the reward earned when taking the risk of owning a business. The Profit and Loss account is a record of the performance of a business over a specific period of time, usually annually.

The first key element of the profit and loss account is what is known as the trading account. This consists of Turnover, Cost of Sales and Gross Profit.

Turnover – This is the amount of sales generated by the business during the period.

Cost of Sales – These are expenses that are directly attributable to production of goods sold/ services given by the business i.e.

  • In a manufacturing industry this would be the materials used to make the product for resale
  • In a retail outlet the good purchased that are then sold on

Gross Profit – This is calculated as the difference between turnover and cost of sales. It is an indicator of the amount of profit being made in relation to the cost of creating it. There are some other key components included within the trading account

Stock – Included within cost of sales is the movement of stock and/ or Work in progress. Stock is items that have been purchased but not yet sold. Work in progress is usually work undertaken that has not yet been invoiced.

Markup – This is the percentage added to the cost of each item sold.

Gross Profit margin – This is the percentage of profit generated from sales.

Knowing the markup and margin that you want to achieve and comparing it with your end of year/ month/ quarter results can be a great indicator to see how your business is doing. You can also compare this against your competitors where you can access their public accounts.

A good example to indicate gross profit would be where you buy an item for £100 and sell it for £150.
This would create following.
Turnover £150
Cost of Sales £100
Gross Profit £50
Profit Margin is 33%, Markup is 50%

If you wish to understand even further feel free to get in touch where we can give you a free consultation on your accounts. Contact us to find out more.