Balance sheet, profit and loss account – what do they mean?

If you’re running a limited company, your company accounts will contain a balance sheet and profit and loss statement. They form part of your statutory annual accounts. But what exactly do these terms mean, and when are you likely to need to use these documents?

What is a profit and loss statement?

Your profit and loss statement shows how much your business has made and how much it has spent in a certain period of time.

One column of this statement shows your revenues (how much has come in), while another shows your expenses (how much has been paid out, such as salaries, taxes or rent).

If the difference is positive, it’s your profit – but if it’s negative, it’s a loss.

Using the P&L statement internally

While sometimes you might find yourself showing your profit and loss statement to external organisations, its main function is to help you (as the company owner), or your accountant establish your firm’s financial health.

As well as allowing you to see at a glance how your business is doing, the P&L statement also points you in the right direction if you need to be raising revenue or slashing costs.

For example, it may only be that once you see everything written down next to each other, you realise that you’re wasting money on a certain expense or missing a trick by not charging a client extra cash.

The profit and loss sheet also allows you to monitor a change in earnings over a period of time. For example, you might produce a profit and loss sheet for the entire year to see how you’ve done over a longer period, followed by one just for the last month.

This gives you an idea of what costs have gone up, for example, meaning you can take better decisions about what your company should be spending on.

What is a balance sheet?

The word “balance” might make you think that this document is just the same as the comparison columns in the profit and loss sheet – but there’s one key difference that you should be aware of.

A balance sheet simply provides a snapshot of how your company is doing at a particular moment in time rather than over a period of months, as a profit and loss sheet would do.

The main aim of a balance sheet is not to show how much cash you’ve made or lost, but to shed some light on how your company is funded instead.

A balance sheet shows not just the liabilities (money you’ve borrowed in order to fund your business), but also your equity (cash that shareholders have pledged up front) and the assets you have.

If the amount designated as assets doesn’t match the amount designated as liabilities, your business could be in trouble.

A balance sheet, then, shows the balance not between cash made and cash lost, but between where the cash has come from and how it has been spent.

When do I need to produce these documents?

All incorporated business have a statutory obligation to provide HMRC with full accounts as part of their company tax return submission. This will include both P&L and balance sheet, as well as notes and a director’s signature.

The accounts must be lodged with HMRC within 12 months of your company’s year-end.

‘Small companies’ (turning over £10.2m or less) don’t need to send these full accounts to Companies House, however.

Instead, you should submit abbreviated annual accounts to the registrar of companies, which include just a balance sheet and any relevant notes.

Aside from these obligations, you will need to produce full financial documents if you ever seek investment, or bank borrowing. Prospective investors, and lenders, will almost certainly want to become familiar with the financial health of your company before committing any funds.

You may also need to prove that your company is in good financial health if you bid for new business. This applies especially to contracts awarded by public sector bodies such as local councils.