Profit and Loss and balance sheet accounts explained

If you’re a CIS or IT contractor or self-employed, you need to understand your profit and loss account and balance sheets.

But what exactly do they mean and how do they apply to you and your business?

What is profit and loss turnover?

Turnover is a term used to describe the net sales of a business or the total income of a contractor.

This figure does not include expenses.

Profit is the name given to the residual sum of money once all expenses have been taken into account.

For example

If you turned over £50,000 and your expenses amounted to £25,000, you’d have a profit of £25,000, for example.

The profit and turnover figures essentially form the outline of your statement for the year.

At the top, you’ll find the turnover, and at the bottom, you’ll find the profit.

If you fail to generate a profit, you’ll make a loss.

This means that your expenses and outgoings exceed the value of your turnover.

A profit and loss account, sometimes called a P&L account, outlines your business income minus outgoings, over the course of a month, a year or a 5-year period.

This will include daily running costs or overheads, such as renting a workshop or office space, and direct costs, such as buying materials.

Your turnover, the amount of money you generate from sales, combined with direct costs, will give you your gross profit value.

This is the amount of profit you generated without factoring in day to day expenses.

Once these costs have been included, this will give you your net profit value.

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Understanding revenue

In accounting terms, revenue relates to the income generated by providing services or selling products to customers.

Your revenue total will include all your sales within a set period of time.

This figure includes any returns or discounts or promotions. It is also known as the top line figure.

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Expenses and cost of goods

Every contractor will have expenses, which will impact the profit margin.

If you’re a CIS contractor, for example, you may have to spend money on buying or hiring tools or equipment.

There are different types of expenses.

Expenses can be directly connected to the services you provide, for example, buying materials, or indirectly linked, for example, paying an administrator.

The cost of goods will affect your balance sheet.

The higher your expenses, the lower your profits.

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Examples for a limited company and a CIS contractor

If you run a limited company, or you’re a CIS contractor, it’s wise to keep a close eye on your turnover and your profits.

Great sales figures don’t necessarily result in huge profits. If you’re spending a lot of money on buying goods, for example, this will impact your profits.

Profit and loss accounts can be useful in providing an insight into where you spend your money, and potentially help you identify areas where you could reduce spending.

Your P&L account will outline details of your turnover followed by your expenses.

Examples may include buying equipment and materials and administrative expenses.

Once you’ve subtracted your expenses from your turnover, you’ll have a more accurate idea of how much profit you’ve actually generated.

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How is profit and loss calculated?

You can use your profit and loss account and balance sheets to calculate profit and loss and get a better idea of your profit margin.

  • To work out the gross profit margin, you’ll need to divide the gross profit by the turnover.
  • To get the net profit, you’ll need to divide your net profit by the turnover.
  • This will give you a per pound profit figure.

You can also work out the amount of profit you’ve generated in a given time period by subtracting all your expenses from your turnover.

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What is a balance sheet?

Balance sheet accounts provide you with information about your business’ assets and liabilities.

In the most basic terms, this relates to what you own and how much money you owe.

The balance sheet will include details about your assets followed by your liabilities.

If you own more than you owe, this will give you a positive number.

If you owe more than you own, the figure at the bottom of your balance sheet will be negative.

Assets and liabilities: how is the balance sheet worked out?

If you’re looking at a balance sheet, you’ll see a series of figures that relate to your assets and liabilities.

Your assets are the things you own, for example, business premises and equipment such as computers.

Other examples of assets include money owed by clients and cash you have in your bank account.

Beneath your assets, you’ll find liabilities.

Examples of liabilities include :

  • Wages owed to staff
  • Loans
  • Mortgages
  • Outstanding tax bills.

At the bottom of your balance sheet, you’ll find a sum that relates to the capital or equity owned by the company director.

This figure is deduced by calculating what would be left over if you were to sell all your assets and pay off any liabilities.

An example balance sheet for a contractor or a small limited company would include fixed and tangible assets, for example, unpaid client invoices and a company van, followed by liabilities, for example, a loan taken to set the business up or expand.

Underneath would be a calculation that is formed by taking the liabilities away from the assets.

The final figure is the capital reserve or shareholder fund.

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How to read a profit and loss balance sheet

As a contractor or a business owner, you may come across a balance sheet and wonder what on earth all the numbers mean.

Essentially, the balance sheet is a window into what your business owns and how much you owe.

If you were to sell up tomorrow, your balance sheet would give you an idea of how much capital you have left in the business once all your outgoings have been taken into consideration.

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At the top of the balance sheet

At the top you’ll find everything you own, for example, cash in the bank, company vehicles, and machinery and equipment.

Then you’ll find figures pertaining to your liabilities.

This is what you owe, and it includes outstanding bills, tax payments that are due in the year ahead, and any loan or mortgage payments.

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At the bottom of the balance sheet

At the bottom, you’ll see a figure, which is calculated by taking your liabilities away from your assets.

If you have money left over once this has been done, you’ll be in the black. If not, the figure will be negative.

Questions or advice ?

If you have any questions about profit and loss or balance sheets, or you’re keen to get a better insight into your finances, contact us.

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