Why Profit And Loss Account for your small business is important:
- Total income
- General Expenses
- Special Note on Depreciation of fixed assets
- Importance of Profit and Loss Account
- Enables you to control expenses
- Provides info to enable you make comparisons
- Generate stats to enable you calculate ratios
- Helps you to make better decisions
- Keep employees and shareholders informed
- Shows the earning capacity of your business
I have, on several occasions, met many small business owners some of who asked me “what is profit and loss account”?
Others asked “what is the importance of profit and loss account”?
Quite a lot of small business owners get frightened when they hear the word “loss”.
Well, their concerns are understandable because no business owner wants to incur losses in his business.
To answer their questions, I usually tell them that it is an important part of annual financial statement that every business is expected to prepare periodically.
Essentially, it is like a report that schools give out to their pupils, detailing their performances.
This article is, therefore, focusing on why it can help you to improve your business.
The profit and loss account typically begins with the gross profits brought down from the trading account.
Profit and loss account can be prepared every three, six or 12 months, depending on the needs of your business.
Typically, incomes from all sources are added to the gross profits to give you total income.
Examples of the items you can find in it include, among others:
- Interests received
- Dividends received
- Rents received
- Profits from sale of fixed assets
- and lots more
Please always bear in mind that what you will find in many profit and loss accounts depends on the industry you belong to.
Therefore, you can follow the practice in the industry you belong to.
The general expenses represent all the costs of running your business during the period under consideration.
Examples of such unavoidable expenses include, among others:
- Salaries and wages
- Printing and stationery
- Transport and traveling expenses
- Depreciation of fixed assets
- And lots more.
At the end of the year, all your business expenses must be deducted from the total income of your business.
Special Notes On Depreciation
In all profit and loss accounts, you will find an item called ‘depreciation of fixed assets’.
It represents the costs or the amount you would have paid if you were to hire the equipment during the period.
That explains why it is written off to the profit and loss account.
Depreciation is usually calculated using the rates approved by the board of inland revenue.
However, depreciation does not involve cash outflow.
In other words, you do not pay out cash for depreciation.
The Importance of profit and loss account
Firstly, one of the most important advantages of preparing profit and loss account for your business is that it can show how your business has fared during the period.
Secondly, it can throw up some interesting stats that will help you to make important decisions concerning your business.
Most importantly, it can reveal the results of your business activities during the given period.
Profit And Loss Account: Control expenses
The profit and loss account can help you to identify areas of your business where you have may challenges.
In particular, profit and loss account can help you to know:
- the expense items that can be eliminated:
- those that can be closely monitored and controlled
- retained because the business needs them to run smoothly
Thus, it is the best place for you to identify unnecessary expenses that are not adding value to your business.
Enables you to make comparisons
In the first place, the Profit and loss account can provide you with info that will enable you to:
- compare this year’s performance with that of the previous year(s).
- compare the trading results with similar businesses in your industry
- to review your marketing and financial management processes
- make better plans that can make your business more competitive.
Secondly, the result of such comparison will enable you to determine whether or not you are:
- in the right industry
- to the stay
- or move to another industry
Profit and loss account: Calculate ratios
In particular, the statement will provide you with stats that will enable you to calculate important ratios.
An example of such ratios include:
- gross profit to sales
- Earning per share
- Dividend yield.
Most importantly, investors and lenders can use them when it is time for them to decide whether or not to do business with you.
Enables you to make better decisions
The profit and loss account can contain useful data that you can use to make better decisions for your business.
For example, it can enable you to consider:
- whether to diversify into other businesses or stay where you are
- how to be more competitive in your industry
Keeps employees and shareholders informed
Firstly, your employees might want to know:
- how well the business they work in has performed
- whether or not the strategies they adopted the period has yielded the desired results.
Similarly, shareholders will want to know:
- how well or badly you have managed their investments in your business
- whether or not to stay with you
- or move their investments to where they will get better returns.
Profit and loss account: earning capacity of your business
It is an important documents the investing public and lenders will certainly want to look at.
This is because they will want to look at the earning capacity of your business before they can consider whether or not to fund your business.
More importantly, the profit and loss account is an important statement that you must prepare for your business.
It is will show you the way to go: the path to profitability and growth.
By Samuel Ijenhi
B. Sc. Accounting [University of Benin]
Benin City, Nigeria.
Founder: Ijenhi Business Solutions