The profit and loss statement shows your business trading figures over a set period, usually a year. It is broken into three main sections showing sales, indirect costs and overhead costs.
Sales
The profit and loss statement starts by showing your sales over a period of time including both sales already paid for, and sales made but not yet paid for.
Direct costs – your cost of sales
Direct costs are the costs of actually providing your product or service such as the cost of buying raw materials. They go up or down depending on how much you make and sell. So if sales go up 10%, you’d expect your direct costs to rise by a similar amount. Direct costs are taken off sales to give a gross profit (sales – direct costs = gross profit).
Overheads – your running costs
Your overheads are the indirect or fixed costs of running your business. They stay the same regardless of how much you sell and have to be paid even if you sell nothing for a time. Overhead costs include things like
- rents and rates
- business insurances
- phone, heating and lighting costs
- annual licensing fees
- office supplies
- wages and salaries.
If you’re not registered for GST, profit and loss is worked out on a gross figure including GST. But if you are registered, profit and loss is worked out excluding GST because this tax money only passes through your business accounts, and is not kept by the business.
Using the profit and loss statement
You can use ratios created from your profit and loss statement to check performance and to measure changes over time. For example you might want to monitor the ratios between direct costs and sales to check that if production goes up or down your sales margin is maintained.
Here are some examples of the ratios you might want to track.
Useful Ratios
| Ratio | How is it worked out? | What does it tell me? |
|---|---|---|
| Quick asset ratio | Divide current assets by current liabilities. | Shows how much cash the business has to cover short-term debts. A ratio of one to one or more shows the business is solvent. |
| Stock turnover | Divide total stock by the average of opening and closing stock figures. | Shows how often stock turns over. For example if over a year this figure is six, it means stock turns over every two months on average. |
| Gross profit margin | Divide gross profit by sales. | It shows how well you’re managing costs and stock. If the ratio falls over time it may mean costs have risen but prices haven’t. |
| Net profit margin | Divide net profit by revenue. | Shows what your profit is and how well all aspects of the business are managed. |
| Indirect costs to sales | Divide indirect costs by sales. | Indicates how well the business is managed. If the ratio rises it may indicate the business is not as profitable as it was. |
