How to create a profit and loss report for your small business

Creating a profit and loss report is a crucial step in managing your business finances. And yet for many small business owners, financial reports can feel a little intimidating.

In reality, a profit and loss report – also known as an income statement or profit and loss statement – is simply a summary of your business's income, expenses and profits over a certain period of time.

This blog takes you through the process of creating a profit and loss report for your small business, using straightforward steps and practical examples.

What is a profit and loss report?

A profit and loss (P&L) report is a financial statement that shows your business's revenue, costs and profits over a set period, such as a month, quarter or year. It's essential for understanding whether your business is making money or operating at a loss.

A P&L report can be particularly valuable for managing cash flow, tracking your performance and meeting HMRC's financial requirements.

Why you need a profit and loss report

• Decision-making tool: A P&L report provides insights into where your money is going. With that knowledge, you can make informed decisions around budgeting, pricing and investment.

• Keeping to tax rules: For UK businesses, a P&L report is necessary for tax purposes, as it provides a clear record of income and expenses for your annual return.

• Attracting investors and securing loans: Potential investors and lenders look to a P&L report to gauge your business's profitability and growth potential.

Key parts of a profit and loss report

To understand how a P&L report works, you need to know what goes into it.

Revenue (or sales)

This is the total income your business generates from selling goods or services. If your business does more than one thing, you can break this down into income lines for the different types of thing you sell.

This helps you understand the profitability of different aspects of the business and where you should focus your energy. For example, if you run an IT company you might divide income into hardware sales and repairs.

Cost of goods sold (COGS)

COGS records the money you spend creating the product or service. Common items include manufacturing and packaging, transportation and so on. Because the cost relates directly to producing the product, the costs normally change based on the amount sold.

If you're VAT registered, the profit and loss report doesn't include VAT. It's something you're collecting on behalf of the government.

As Yarka Krajickova, Enterprise Nation adviser and accountant, explains:

"Nowadays, there are so many software packages that allow you to measure COGS and create the report at any point in time. Most are not very user-friendly. The problem is if you put garbage in, you get garbage out."

Yarka stresses the last point – you need to keep on top of your bookkeeping to make sure you get the right insights.

Gross profit

This is calculated as revenue minus COGS and shows your profit before deducting operating expenses. Yarka suggests comparing the gross profit between different months.

"It's really good to do the COGS calculations and see how the COGS has performed. Have you spent more or less and why? When you start your business, you don't know the charges. After a while you get a feel for it, is it too much? Should you be looking for another supplier?"

Operating expenses

These are all the other day-to-day expenses necessary for running your business, like rent, utilities, wages and marketing.

Net profit (or net income)

This is your gross profit minus operating expenses and represents your business's final profit after all costs.

How to create your own P&L report

Here's a step-by-step guide to creating your P&L report, even if you have little to no experience with financial reporting.

Step 1: List your revenue streams

The first step is to gather all sources of income over the period you're reporting. This could include:

• sales revenue from products

• income from services rendered

• any additional revenue streams, such as rental income or interest

Example: If your business earned £10,000 from product sales and £2,000 from services in a given month, your total revenue is £12,000.

Step 2: Calculate your cost of goods sold (COGS)

Next, work out the COGS, which includes all expenses directly tied to producing your products or services. If you're a service-based business, COGS might include the cost of subcontracted labour or materials directly used in delivering the service.

Example: If you spent £3,000 on raw materials and £500 on production labour, your COGS would be £3,500.

Step 3: Determine your gross profit

To find your gross profit, subtract your COGS from your revenue as per this formula:

Gross profit = Revenue – COGS

Using our examples above, your gross profit is £12,000 – £3,500 = £8,500.

Step 4: Identify and list operating expenses

Operating expenses cover all the regular costs of running your business, like:

• rent

• utilities

• salaries and wages

• office supplies

• marketing expenses

Example: Suppose your operating expenses for the month are:

• Rent: £1,000

• Utilities: £300

• Salaries: £2,000

• Marketing: £200

Your total operating expenses would be £3,500.

Step 5: Calculate net profit

Finally, calculate your net profit by subtracting your total operating expenses from your gross profit, as per this formula:

Net profit = Gross profit – Operating expenses

In our example, net profit is £8,500 – £3,500 = £5,000.

Tools and templates for creating a profit and loss report

If you're new to creating P&L reports, there are several tools and templates available that can make the process simpler.

Accounting software

Options like Sage, QuickBooks, Xero and FreeAgent are popular among UK small businesses. They automate much of the process and offer customisable reports.

Yarka says if you're a small, straightforward company with no loans, you can create a profit and loss in Excel or another piece of accounting software.

Accounting software is relatively user-friendly and can allow you to create these kinds of reports automatically. It's worth watching tutorial videos and reading the help articles of the provider you choose, particularly if you don't have an accountant to help set everything up.

Yarka says:

"There are lots of people who are switched on enough to do it themselves. If they're not, they mustn't be afraid to ask for help."

Templates

Microsoft Excel and Google Sheets offer free P&L templates that are simple to use.

DIY vs. hiring an accountant

For small businesses with straightforward finances, creating a P&L report yourself is manageable. However, if you feel unsure or need more guidance, consulting an accountant can be worthwhile, especially for accuracy during tax season.

Whatever method you choose for creating a profit and loss report, it's important to think about it when you start a business. Yarka advises:

"Don't wait 18 months to do your accounts or contact an accountant. Things will be more expensive and the data won't be there. Look at it as soon as you start the business.

"Accountants have a good idea of the expenses a business should have, and getting advice can help. Also, many accountants offer guidance for free."

Find an accountant or financial adviser on Enterprise Nation

Best practice for managing your profit and loss reports

To make the most of your P&L reports, keep these best practices in mind:

• Maintain consistency: Create a P&L report regularly – every month, quarter or year – to monitor trends and assess changes over time.

• Always be accurate: Double-check entries for accuracy to avoid underestimating costs or overstating income.

• Use insights for improvement: Regularly reviewing your P&L report can help you identify areas to cut costs, price adjustments and opportunities for growth.

Common mistakes to avoid in your profit and loss report

• Ignoring small expenses: Small costs add up. Include every expense, no matter how minor, to get a full picture of your business's financial health.

• Mixing personal and business expenses: Always separate personal and business expenses to make sure your reporting is accurate and avoid issues with HMRC.

• Not reviewing regularly: Many small business owners neglect to review their P&L reports periodically. Regular reviews make sure you're always aware of your financial position and can spot issues early.

Frequently asked questions about profit and loss reports

What is the purpose of a profit and loss report?

A P&L report allows you to track your income and expenses, calculate profit and make informed business decisions. It's essential for tax reporting and understanding your business's financial health.

How often should I create a P&L report?

Profit and loss accounts cover a specific period. The minimum requirement for limited companies is to create one at the end of the year. However, you could look at the report every six months or even every month.

The frequency depends on how it will affect your decision-making and how complicated it is to create. If you're using accounting software, you can produce the report in a matter of minutes.

Yarka Krajickova explains:

"The regularity depends on how big your business is. If your turnover is under £40,000, you could get away with quarterly. Above that, it should be monthly. It gives you a picture of the business as it is and will help you understand how to grow.

"Whatever period you choose to cover, it's really helpful to get into a regular routine. The better you understand how your business is performing, the more informed decisions you can make."

What is the difference between a P&L report and a balance sheet?

A P&L report shows revenue, expenses and profit over a specific period. A balance sheet provides a snapshot of assets, liabilities and equity at a particular point in time.

Key takeaways

Creating a P&L report is a valuable skill for any small business owner. By following these simple steps, you can gain better control over your finances, make smarter decisions and plan for future growth.

Remember, a P&L report isn't just a document – it's a tool for understanding your business's financial health and making sure you're on the path to success. 

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