Finance for Non-financial Managers

1. Profit and Loss

Profit is essential in the longer term. Without profits, you will need to continually raise additional financing (or sell assets) to keep trading.

1.1 The profit and loss statement provides a picture of the company's trading performance over the last 'accounting period' (usually a year).

The profit and loss statement records sales, costs and expenses, profits (and losses), and any tax provisions for the period, even if they have not yet been paid. For example:

• Sales and purchases are recorded when the sale or purchase is invoiced.
• The costs of fixed assets (eg vehicles) are spread over their useful working lives.Rather than charging the full cost when the asset is purchased, an annual 'depreciation' charge is made instead.
• Prepayments (eg rent in advance) and accruals (eg interest payable later) are matched to the period they relate to.

1.2 The statement usually follows a relatively simple format.

• Turnover (or sales), excluding VAT.
• Cost of sales.This represents 'direct' costs, such as raw materials. These costs usually rise in line with the volume of sales.
• Gross profit. Turnover less cost of sales.
• 'Indirect' costs (or overheads) such as rent, rates and salaries. This will include depreciation on fixed assets.
• Operating profit or profit before interest and tax (PBIT).PBIT also includes non-operating income and costs (eg if you sell an asset).
• Net interest payable (eg on bank loans).
• Profit before tax (ie after deducting interest charges from PBIT).
• Tax payable.
• Net profit.

1.3 You may need to ask questions to get a clear understanding of what the profit and loss statement is telling you. The profit and loss statement reflects an element of judgement. For example:

• How much of the income from a long-term contract (eg five years) should be included in that year's profit.
• What adjustments to make for customers who are unlikely to pay.
• How quickly to depreciate fixed assets.