The profit and loss account (P&L) is a financial statement that summarises a company’s income, costs and expenses during a specific accounting period. It shows whether the business has made a profit or a loss and is one of the primary financial statements required by the Companies Act 2006.
In international and US terminology, this statement is called the income statement. UK company law and FRS 102 both refer to it as the profit and loss account, though in practice both terms are used interchangeably by UK accountants.
Structure of the P&L
The Companies Act 2006 prescribes two formats for the profit and loss account. Format 1 (analysis by function) is the most commonly used by UK companies:
| Line item | £ |
|---|---|
| Turnover | 800,000 |
| Cost of sales | (480,000) |
| Gross profit | 320,000 |
| Distribution costs | (45,000) |
| Administrative expenses | (185,000) |
| Operating profit | 90,000 |
| Interest receivable | 1,200 |
| Interest payable | (8,500) |
| Profit before tax | 82,700 |
| Tax on profit | (17,367) |
| Profit after tax | 65,333 |
Each line tells a different story about the business’s performance and is examined by directors, investors, lenders and HMRC.
Key Line Items Explained
Turnover
Turnover is the UK term for revenue or sales. It represents the total income from the company’s ordinary activities, excluding VAT. Under FRS 102, turnover is recognised when goods or services have been delivered and the amount can be measured reliably.
Cost of Sales
The direct costs of producing or purchasing the goods or services sold. For a manufacturer, this includes raw materials, direct labour and production overheads. For a retailer, it is the purchase cost of stock sold.
Gross Profit
Gross profit is turnover minus cost of sales. It measures the profitability of the core trading activity before any operating expenses are deducted.
Gross profit margin = (Gross profit / Turnover) x 100
| Sector | Typical gross margin |
|---|---|
| Retail (food) | 25-35% |
| Retail (clothing) | 50-60% |
| Manufacturing | 30-45% |
| Professional services | 60-80% |
| Construction | 15-25% |
| Software/SaaS | 70-85% |
Operating Profit
Operating profit is gross profit minus distribution costs (delivery, warehousing, sales commissions) and administrative expenses (rent, office salaries, professional fees, insurance). It measures the profit generated from the business’s normal operations before interest and tax.
Interest and Finance Costs
Interest receivable (income from bank deposits or loans made) and interest payable (cost of borrowings, overdrafts and finance leases) are shown separately below operating profit.
Profit Before Tax
This is the figure on which corporation tax is broadly based, though the taxable profit differs from accounting profit due to disallowable expenses and capital allowances.
Profit After Tax
The bottom line. This is the profit available to shareholders, from which dividends may be paid.
Net Profit
Net profit is sometimes used interchangeably with profit after tax, though it can also refer to profit before or after tax depending on the context. In the UK statutory format, the bottom line is profit for the financial year.
Net profit margin = (Profit after tax / Turnover) x 100
| Metric | Company A | Company B |
|---|---|---|
| Turnover | £1,000,000 | £1,000,000 |
| Gross profit | £400,000 | £600,000 |
| Operating profit | £100,000 | £150,000 |
| Profit after tax | £75,000 | £110,000 |
| Net profit margin | 7.5% | 11.0% |
Company B has a higher net margin despite the same turnover, indicating either better cost control or a more profitable product mix.
UK vs International Terminology
| UK term | International / US term |
|---|---|
| Profit and loss account | Income statement |
| Turnover | Revenue |
| Stock | Inventory |
| Debtors | Receivables |
| Creditors | Payables |
| Profit for the financial year | Net income |
| Profit and loss reserve | Retained earnings |
The differences are purely terminological. The underlying accounting principles are the same.
P&L for Different Company Sizes
The level of detail required in the P&L depends on the company’s size under the Companies Act:
| Size category | P&L requirements |
|---|---|
| Micro entity | Simplified profit and loss account showing turnover, other income, cost of raw materials, staff costs, depreciation, other charges, tax and profit/loss |
| Small company | May start the P&L at gross profit (omitting turnover and cost of sales) when filing at Companies House |
| Medium company | Full P&L with some reduced disclosure |
| Large company | Full P&L with complete notes and disclosures |
Small companies filing abridged accounts at Companies House may omit turnover, but the full P&L must still be prepared for shareholders and HMRC.
Reading the P&L
Trend Analysis
Comparing the P&L over several periods reveals trends in revenue growth, margin compression or expansion, and cost control:
| Metric | Year 1 | Year 2 | Year 3 |
|---|---|---|---|
| Turnover (£) | 700,000 | 800,000 | 850,000 |
| Gross margin (%) | 42% | 40% | 38% |
| Operating margin (%) | 14% | 11% | 10% |
In this example, turnover is growing but margins are falling. This may indicate rising input costs, competitive pricing pressure, or poor cost control.
Common-Size Analysis
Expressing every line item as a percentage of turnover makes it easier to compare businesses of different sizes:
| Line | Amount (£) | % of Turnover |
|---|---|---|
| Turnover | 800,000 | 100% |
| Cost of sales | 480,000 | 60% |
| Gross profit | 320,000 | 40% |
| Distribution costs | 45,000 | 5.6% |
| Admin expenses | 185,000 | 23.1% |
| Operating profit | 90,000 | 11.3% |
P&L and the Balance Sheet
The profit and loss account and the balance sheet are connected through the profit and loss reserve (retained earnings). The profit after tax from the P&L, less any dividends paid, flows into the retained earnings figure on the balance sheet.
Closing retained earnings = Opening retained earnings + Profit after tax - Dividends
This link ensures that the two primary financial statements reconcile and together provide a complete picture of a company’s financial position and performance.
P&L and Tax
The profit before tax shown in the P&L is not the same as the taxable profit reported to HMRC. Key adjustments include:
- Depreciation is added back and replaced by capital allowances
- Entertaining costs are disallowable for tax purposes
- Fines and penalties are not deductible
- Capital gains are taxed separately
These adjustments are made in the corporation tax computation, which reconciles accounting profit to taxable profit.