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Income statements - P&L accounts

A P&L account is a statement of sales less costs for a period, normally one year or sub-periods thereof. It shows sales (also called turnover, income or revenue) less costs (or expenses) grouped in various ways, the end result being the net profit or income of the business for the period stated. In its simplest format a P&L account starts with sales or income from which all costs or expenses are deducted, and the net result is a profit, when costs are less than sales, or a loss when costs exceed sales:

Profit & Loss Account for the period ended

Sales, income or revenue 900

Costs or expenses (810)

Net profit or (loss) 90

In accounting terms, a profit or loss is the result of deducting all costs for a period from all income for the defined time period. While this is in essence a very simple concept and thus statement, it will be obvious that the correct inclusion of income and costs is critical. The correct 'cut-off between periods is critical.

A very common practice is to distinguish between costs of purchased items, costs of manufacturing or other direct costs of providing goods or services, and the general, indirect or overhead costs of running a business:

Profit & Loss Account for the period ended

Sales income or revenue 900

Cost of sales (690)

Gross profit 210

Expenses/overheads (120)

(grouped together either for management purposes or to meet statutory requirements)

Net profit before tax 90

Cost of sales

This should be the direct costs of the services provided or goods supplied: eg for a manufacturer almost all factory costs, labour materials and factory overheads; for a consultancy firm the cost of salaries; for a retailer the cost of merchandise at purchase price.

Which costs are classified as cost of sales is often determined by convention, that is, by copying what everyone else in the sector does. However the classification is decided upon, it is important that the rationale of classification is clear, unambiguous and, above all, consistent. In published accounts, gross profit is often not a useful figure since, certainly in the United Kingdom, there is no statutory definition of cost of sales. Companies tend to obscure their true gross profits by adding in overhead costs and other expenses.

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