Ever looked at your accounts and skimmed straight over them?
When a set of accounts lands, most people do the same thing. A glance at the profit figure, maybe, then it gets filed away, the rest barely registers.
For some business owners, that once-a-year look is the only time the numbers show up at all, months after the year has ended and long after they could have done anything with them. The rest of the time they run on the bank balance, because it is the only number in front of them and the only one they fully trust.
That is the gap. These two reports answer the questions you ask yourself all the time. Am I making money? Can I afford to pay myself this month? Is the money in the bank actually mine to spend? You don’t need to be an accountant to read them, you just need someone to show you what each line is for.
This post walks through both reports. What a profit and loss tells you, what a balance sheet tells you and why they are not the same thing.
Your profit and loss: did the business make money?
Start with the profit and loss, often shortened to P&L. This is the one worth understanding first because it answers the day-to-day questions most owners care about.
A P&L covers a period of time. A month, a quarter, a year, etc. It shows everything you earned over that period, subtracts the costs incurred and shows what’s left over.
Read top down, it goes like this.
1. Income/Turnover. This is all your sales or income. The money you earned from the work you did or the goods you sold in that period. Not just what landed in the bank, what you actually invoiced or took.
2. Direct costs. The costs tied directly to that work. Materials, stock, registrations/licences, subcontractors, anything that you have to pay for or you couldn’t complete the work. Take these off your income and you get your gross profit, which is what the work itself makes before the running costs of the business.
3. Overheads/expenses. The costs of keeping the business going, whether you sell anything or not. Software, insurance, marketing, training, phone bills, that sort of thing.
4. Net profit. Income, less direct costs, less overheads. This is the number at the bottom and it is the one that matters. It is what the business actually made over the period.
The key thing to remember is that the P&L is about performance over time. Think of it as an overview of what happened between two dates.
Reading it without glazing over
You do not need to study every line. Two habits get you most of the way.
Look at net profit first, then look at how you got there. If profit is down on last month, the P&L shows you why. Did income drop, or did a cost jump? The answer is sitting right there and it is usually the difference between “I need more work” and “I need to look at what I am spending.”
The second habit is to compare periods rather than reading one in isolation. One month on its own tells you very little. This month against last month, or this quarter against the same quarter last year, tells you the direction you are heading. Direction is what you make decisions on.
Your balance sheet: what you own and what you owe
The balance sheet is the other report and it does a different job.
Where the P&L covers a period, the balance sheet is a single moment. A snapshot of where the business stands on one particular day.
It sets out three things.
What you own. Cash in the bank account, equipment, stock and money your customers still owe you. Anything of value the business holds.
What you owe. Money you owe suppliers, loans, VAT building up ready to be paid and PAYE tax if you have a payroll. Bills the business has taken on but not yet settled.
What is left. Take what you owe off what you own and the difference is the real worth of the business at that moment.
This report explains the question that catches people out. The bank looked fine, so why is money tight? Because some of that cash was never yours to spend. It was tax owed and suppliers to pay, sitting on the balance sheet waiting. The P&L will not show you that, the balance sheet will.
Why the two are not the same thing
A business can be profitable and still be short of cash. The P&L can show a healthy net profit while the balance sheet shows very little in the bank, because the profit is tied up in customers who have not paid yet, or has already gone out to cover tax and suppliers.
The two reports are not rivals and one is not the “real” one. They answer different questions.
The P&L tells you whether the business is performing. The balance sheet tells you whether it can meet what it owes. You need both to see the whole picture. Once you can read them together, the numbers stop being scary or just another thing the accountant deals with and start being something you run the business on.
Common questions
What is the difference between a profit and loss and a balance sheet?
A profit and loss shows how your business performed over a period, such as a month, a quarter or a year. A balance sheet shows what your business owns and owes at a single point in time. They answer different questions, so you need both to understand where you stand.
Can a business be profitable and still run out of cash?
Yes. Profit can be tied up in invoices your customers have not paid yet, or already committed to tax and suppliers. So a business can look profitable on paper and still be short of cash in the bank.
NEED A HAND?
If you need everything updated so you can read your reports, or if your own numbers still feel like a foreign language, that is exactly the sort of thing worth handing over. Good bookkeeping isn’t just tidying the numbers, it is making sure you understand what they are telling you. Book a discovery call and we will talk it through.
Disclaimer: We make reasonable efforts to keep this content up to date, but we do not guarantee that it is current, accurate, or complete. This article is for general information purposes only and does not constitute legal, financial, or tax advice. Please seek professional advice before acting on anything here.
