How to read a statement of profit or loss

The statement of profit or loss answers one question: did the business make a profit or a loss over the period? It is also called a profit and loss account.

It covers a whole period, so its heading reads: for the year ended, and then the last day of that year.

Income

What the business earns, from sales for the most part.

Expense

A cost of running the business in the period.

Profit for the year

Income is more than expenses.

Loss for the year

Expenses are more than income.

Income and costs go into the year they are earned or used. The date the money moves does not decide it.

The statement is built in steps, and always in the same order. Read it in that order.

1. Read the heading. It names the business and the period the figures cover.
2. Revenue: sales less sales returns. It is what the business earned from customers in the period.
3. Cost of sales: what the goods sold cost the business. It is opening inventory, plus purchases less purchases returns, plus carriage inwards, less closing inventory.
4. Gross profit: revenue less cost of sales. It is the profit on trading, before the running costs.
5. Expenses: the other costs of running the business, such as wages, rent, electricity, carriage outwards and the depreciation charge for the year.
6. Profit or loss for the year: gross profit less expenses. If the expenses come to more than the gross profit, this line is a loss.
7. Follow the last line to the statement of financial position. The profit belongs to the owner, so it is added to capital there.

Profit for the year is also called net profit.

Assets, liabilities, capital and drawings are not income or expenses. They stay out of this statement and go to the statement of financial position.

• Drawings. Money or goods the owner takes out reduce capital. They are not a cost of running the business.
• The cost of an asset that lasts for years, such as a van or shop fittings. Only the depreciation charge for the year is an expense.
• Money the owner pays in. It is capital, not income.
• A bank loan. The amount owed is a liability.
• Money owed by customers and money owed to suppliers. They are an asset and a liability.

Timing stays out too. Being paid sooner by a customer, or paying a supplier later, moves cash. It does not change profit.

Lantern Yard Florist is owned by one person. In the year it made sales of £84,500.00, and customers returned goods worth £500.00.

Revenue is £84,500.00 less £500.00, which is £84,000.00. Cost of sales is £40,100.00, so gross profit is £43,900.00.

The five expenses come to £30,600.00. Gross profit of £43,900.00 less £30,600.00 leaves a profit for the year of £13,300.00.

Two figures from the same books are not in the statement. The owner took out £11,000.00 during the year: drawings. The delivery van cost £9,500.00: an asset. Only the van's depreciation of £1,600.00 is an expense of this year.

• Treating drawings as wages. Wages are an expense and drawings are not, so profit comes out too low.
• Putting the whole cost of a van or of fittings in the expenses. The cost is shared over the years of use as depreciation.
• Mixing up the two kinds of carriage. Carriage inwards is part of cost of sales. Carriage outwards is an expense below gross profit.
• Reading gross profit as the final figure. The running expenses still have to come out of it.
• Reading profit as money in the bank. Profit counts income when it is earned and costs when they are used. Drawings and the cost of a new van both move cash without being expenses.
• Reading one year alone. Set the gross profit beside last year's, as a share of sales, to see whether each pound of sales leaves more or less than before.

• The heading says for the year ended, not as at.
• Revenue less cost of sales equals gross profit, and gross profit less total expenses equals the profit or loss for the year.
• Every income and expense balance in the trial balance appears once. No asset, liability, capital or drawings balance appears at all.
• Closing inventory in cost of sales is the same figure as inventory in the statement of financial position.
• Opening capital, plus the profit for the year, less drawings, equals closing capital. Closing capital equals the net assets.