Should You Prepare a Monthly Profit and Loss Account?
If you've been running a small business for a couple of years, you may be relatively happy with your performance and may even be thinking about expansion. Yet if you are simply relying on your own rudimentary calculations, you may not be in total control and run the risk of encountering problems down the road. While you may certainly create a set of accounts at the end of a trading year, would it be better if you were to craft a profit and loss statement each month instead?
Defining Profitability
Some people think that as long as there's enough money in the bank to meet bills on a regular basis, they must automatically be profitable. However, this is not necessarily the case. There is a significant difference between trading accounts and cash flow. One represents outright performance while the other is meant to smooth out any peaks and troughs in a bank account.
Expenditure on Tax
The profit and loss account (P&L) categorises expenditure based on whether the money was spent to create the goods and services for sale or it was related to the business support function (also known as overheads). Different tax rules apply to various categories of expenditure, and if you are not itemising as you should, you may run the risk of completing an incorrect tax return.
Understanding the Information
You don't have to produce a profit and loss account each month, but it is a very good indicator of the health of the business. From the P&L, you can also create a balance sheet which many feel is the ultimate arbiter of whether a company is solvent or not. After all, it's possible to have a periodic P&L that shows a healthy profit, but the balance sheet may show negative equity. This can happen if the company is very leveraged and owes a lot of money to third parties.
Monthly Calculations
It's relatively simple to create a monthly profit and loss account. If some bills are only incurred quarterly or annually, you simply need to prorate those costs. Depending on the accounting method used, you can then account for income either when it is received or when it is billed. Nevertheless, you should maintain the same approach to accounting methods across the year for consistency's sake.
Preparing the Statements
Do you work with an accountant already? If not, it's a good idea to bring one in and ask them to prepare monthly profit and loss statements instead. This will give you a clear picture as the months go by and give you more confidence if you want to expand. Also, if you need to borrow for expansion, banks or other lenders will welcome the additional information.
Contact a local accountant to learn more.
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