Whether you operate as a Sole Trader or through a Limited Company, you will have seen a Profit & Loss account (or P&L for short). This shows your income less your running costs over a period of time (usually a year although can be monthly or quarterly).
Income from sales is known as turnover. Other income could be interest income or commission.
The running costs are split into direct costs that relate directly to sales, and overheads, which are general running costs. For example, direct costs could be materials used to make items for sale or the cost of sending finished goods to customers. Overheads could be general office costs such as rent and rates, staff wages or legal fees.
Gross and Net Profit
Gross Profit is calculated as turnover less direct costs whereas Net Profit is total income less all of a business’ day to day running costs.
Gross Profit Margin is calculated by dividing gross profit by turnover while Net Profit Margin is net profit divided by turnover. These figures show the level of profit your business is making related to your sales. Margins can be compared from one period to the next to allow you to track your profitability. If your margin has gone down this shows that you aren’t keeping as much of your income from sales – maybe due to a decrease in prices or from an increase in expenses.
The example above shows the benefits of using software such as Xero, which enables you to view an up to date P&L account to spot changes in profitability. You then have the opportunity to act upon your findings quickly to avoid long term damage to your business.