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A profit and loss account shows how much your business earned and spent over a period, usually a year, and whether it made a profit. A balance sheet is a snapshot of what the business owns and owes on a single date. You need both: the profit and loss tells you how the business performed, while the balance sheet tells you how financially strong it is.
Many owners look only at the bottom line of their annual accounts and file the rest away. Yet a few minutes with these two statements can show whether prices are too low, whether cash is building up or draining away and how much you can safely take out. This guide explains the key lines on each, the main differences and a worked example for a small Bolton business.
What is a profit and loss account?
The profit and loss account (P&L), also called the income statement, covers a period of time, such as the year to 31 March 2026. It starts with sales and deducts costs in stages:
| Line | What it shows |
|---|---|
| Turnover (sales) | Income from selling goods or services, excluding VAT |
| Cost of sales | Direct costs of what you sold, such as stock, materials or subcontractors |
| Gross profit | Turnover minus cost of sales |
| Overheads (administrative expenses) | Running costs: wages, rent, utilities, insurance, software, accountancy |
| Depreciation | The cost of equipment and vehicles spread over their useful life |
| Operating profit | Gross profit minus overheads and depreciation |
| Interest | Interest on loans and overdrafts |
| Profit before tax | The figure Corporation Tax is based on, after tax adjustments |
| Tax | Corporation Tax for a limited company |
| Profit after tax | What is left for the owners, as dividends or kept in the business |
Key profit and loss ratios
- Gross margin (gross profit ÷ turnover) shows whether your pricing covers your direct costs. A falling margin often means supplier prices have risen faster than yours.
- Net margin (profit before tax ÷ turnover) shows how much of each pound of sales becomes profit.
- Overheads as a share of sales shows whether running costs are growing faster than the business.
Depreciation appears in the profit and loss but is not allowed for tax. HMRC gives capital allowances instead, which is why taxable profit is rarely the same as accounting profit.
What is a balance sheet?
The balance sheet shows the position on the last day of the period. It always balances, because what the business owns, less what it owes, equals the owners’ stake.
| Section | Examples |
|---|---|
| Fixed assets | Equipment, vehicles, fixtures, property |
| Current assets | Stock, money owed by customers (debtors), cash at bank |
| Current liabilities | Amounts due within a year: suppliers, VAT, PAYE, Corporation Tax, overdraft |
| Net current assets | Current assets minus current liabilities, a quick test of short-term health |
| Long-term liabilities | Loans repayable after more than a year |
| Net assets | Total assets minus total liabilities |
| Capital and reserves | Share capital plus retained profits, which equals net assets |
Watch the director’s loan account, which can sit in either debtors or creditors. If you have taken more out of the company than you put in, our guide to the director’s loan account explains the tax risks.
Profit and loss vs balance sheet: the key differences
| Profit and loss account | Balance sheet | |
|---|---|---|
| Time frame | A period, such as 12 months | A single date |
| Main question | Did we make a profit? | What do we own and owe? |
| Key figures | Turnover, gross profit, net profit | Cash, debtors, creditors, net assets |
| Links to tax | Basis for Corporation Tax or Self Assessment | Shows tax owed at the year end |
| Link between them | Profit after tax, less dividends | Added to retained profits |
The two statements are connected. Each year’s profit after tax, less any dividends paid, is added to retained profits on the balance sheet. A business can be profitable on its profit and loss and still run short of cash, for example if customers pay slowly or profits are tied up in stock and equipment.
Worked example: a Bolton café
Bradshawgate Coffee Ltd runs a café in Bolton town centre. Its profit and loss account for the year to 31 March 2026:
| Profit and loss account | £ |
|---|---|
| Turnover | 180,000 |
| Cost of sales (food, drink, packaging) | (72,000) |
| Gross profit | 108,000 |
| Wages | (52,000) |
| Rent and rates | (18,000) |
| Utilities | (6,000) |
| Other overheads | (7,000) |
| Depreciation | (3,000) |
| Operating profit | 22,000 |
| Loan interest | (1,000) |
| Profit before tax | 21,000 |
| Corporation Tax at 19% | (3,990) |
| Profit after tax | 17,010 |
The gross margin is 60% and the net margin is about 11.7%. For simplicity, the tax charge assumes taxable profit equals accounting profit.
Its balance sheet at 31 March 2026:
| Balance sheet | £ |
|---|---|
| Equipment at cost less depreciation (24,000 less 9,000) | 15,000 |
| Stock | 3,000 |
| Debtors | 2,000 |
| Cash at bank | 21,000 |
| Current liabilities (suppliers 6,000, Corporation Tax 3,990, VAT 4,010) | (14,000) |
| Net current assets | 12,000 |
| Bank loan due after one year | (8,000) |
| Net assets | 19,000 |
| Share capital | 100 |
| Retained profits (13,890 brought forward + 17,010 profit less 12,000 dividends) | 18,900 |
| Total capital and reserves | 19,000 |
What the owners learn:
- The café is profitable, with a healthy gross margin.
- Cash of £21,000 looks comfortable, but £7,000 of it is already owed to HMRC for Corporation Tax and VAT.
- The £12,000 of dividends were covered by profits, so they were legal to pay.
- If food costs rose by five percentage points of sales, gross profit would fall by £9,000 and wipe out over 40% of the profit.
Hospitality margins are tight, which is why our accountants for restaurants review these figures with clients regularly.
What small companies file at Companies House
Private companies must file annual accounts within 9 months of their year end. At present, a micro-entity can file only a simplified balance sheet, and small companies can choose not to file their profit and loss account. A company is a micro-entity if it meets two of: turnover of £1 million or less, a balance sheet of £500,000 or less and 10 or fewer employees.
This is changing. Companies House has confirmed that from April 2028, all companies must file accounts using software, and small companies and micro-entities will have to file a profit and loss account, with an option not to publish it. Abridged accounts will also end. You still prepare a full profit and loss for HMRC with your Corporation Tax return.
Frequently asked questions
What is the difference between a profit and loss account and a balance sheet?
A profit and loss account shows income, costs and profit over a period. A balance sheet shows what the business owns and owes on one date. Profit from the first feeds into retained profits on the second.
Which is more important, profit and loss or balance sheet?
Both matter. The profit and loss shows whether the business is making money, while the balance sheet shows whether it can pay its debts and how much value has built up.
Do sole traders need a balance sheet?
Not for HMRC. Sole traders report income and expenses on their Self Assessment return, usually on the cash basis. A balance sheet is still useful for lenders and for tracking what the business owns.
Do small companies have to file a profit and loss account?
Not yet. Small companies and micro-entities can currently leave it out of the accounts filed at Companies House. From April 2028 they will have to file one, although they will be able to keep it off the public register.
Why is my profit different from my bank balance?
Profit includes sales you have invoiced but not been paid for and excludes money spent on equipment, loan repayments and dividends. Timing differences like these explain most gaps.
Understand your numbers with Cangaf
Your annual accounts should help you run the business, not just keep you compliant. Cangaf’s ACCA-qualified team prepares annual accounts and Corporation Tax returns for Bolton businesses and explains what the figures mean. With up-to-date bookkeeping, you can see your profit and loss every month, not once a year. Request a fixed-fee quote.
Official guidance: Accounts for micro-entities, small and dormant companies, Preparing and filing Companies House accounts and Companies House changes to accounts filing from April 2028.
