- The profit and loss account and balance sheet at a glance
- What GOV.UK says statutory accounts must include
- What's in a profit and loss account
- What's on a balance sheet
- How the two reports connect
- Common mix-ups between the profit and loss account and balance sheet
- How often to look at each report
- A plain example of how the two reports differ
- What lenders and buyers look for in these reports
- Getting both reports from your bookkeeping
- Reading your reports with an accountant
- Frequently asked questions
A profit and loss account shows your sales, running costs and the profit or loss you made over a period, such as a month or a year. A balance sheet shows what the business owns, owes and is owed on one particular day. One is a film of your trading, the other is a photo of your position. You need both to understand your business.
Two reports sit at the heart of every set of accounts, and they're easy to mix up. The profit and loss account, often called the P and L or income statement, tells you how the business performed. The balance sheet tells you where it stands. GOV.UK's guidance on annual accounts for limited companies puts it neatly, and I'll lean on it here alongside standard accounting definitions.
The profit and loss account and balance sheet at a glance
| Report | What it shows | Time frame |
|---|---|---|
| Profit and loss account | Sales, running costs and the profit or loss made | A period, such as a month, quarter or financial year |
| Balance sheet | What the business owns, owes and is owed | A single date, such as the last day of the financial year |
What GOV.UK says statutory accounts must include
If you run a private limited company in the UK, this isn't optional. GOV.UK says statutory accounts must include a balance sheet, which shows the value of everything the company owns, owes and is owed on the last day of the financial year, and a profit and loss account, which shows the company's sales, running costs and the profit or loss it has made over the financial year, along with notes about the accounts. A director's report is needed too unless the company is a micro-entity.
Sole traders don't file accounts in the same way, but the two reports are just as useful for running the business and for conversations with lenders.
What's in a profit and loss account
- Sales or turnover for the period.
- Cost of sales, the direct cost of what you sold.
- Gross profit, sales minus cost of sales.
- Overheads such as rent, wages, software and marketing.
- Operating profit, then interest and tax.
- Net profit or loss, the bottom line.
It answers one big question: did the business make money over this period? My explainer on gross and net profit goes deeper into the layers, and if you need a starting template, my guide to claiming business expenses shows how expenses feed into the picture.
What's on a balance sheet
A balance sheet lists three things on a specific date. Assets are what the business owns or is owed, such as cash in the bank, equipment, stock and money customers owe you. Liabilities are what it owes, such as loans, supplier bills and tax due. Equity, sometimes called capital, is the difference between the two, the part that belongs to the owners.
The name comes from the idea that the two sides balance: assets equal liabilities plus equity. If they don't, something has been recorded in the wrong place.
How the two reports connect
The reports aren't separate worlds. Profit made during the year, once any money taken out by owners is accounted for, adds to equity on the balance sheet. A loss reduces it. So a run of profitable months should show up as a stronger balance sheet over time.
This is also why a profitable business can still run short of cash. The profit and loss account might show a healthy profit, while the balance sheet shows a lot of money tied up in stock or unpaid customer invoices. Cash in the bank lives on the balance sheet, not on the P and L.
| Question you're asking | Look at |
|---|---|
| Did we make money last quarter? | Profit and loss account |
| How much do customers owe us? | Balance sheet |
| Are overheads creeping up? | Profit and loss account |
| Can we take on a loan? | Both, especially the balance sheet |
| Is too much cash stuck in stock? | Balance sheet |
Common mix-ups between the profit and loss account and balance sheet
- Thinking profit means cash. You can be profitable and still struggle to pay bills if customers pay late.
- Putting equipment through the P and L. Larger purchases usually sit on the balance sheet as assets, with depreciation spreading their effect over time.
- Ignoring the balance sheet altogether. Many owners only look at profit, but debts and money owed to you matter just as much.
- Comparing different periods. Make sure you compare a month with a month, or a year with a year.
How often to look at each report
A monthly profit and loss account is the single most useful habit for a small business. It shows trends early, while there's still time to change what you charge or cut overheads. The balance sheet is worth checking monthly or quarterly, especially money owed to you and money you owe.
Most accounting software produces both reports automatically if your bookkeeping is up to date. If you're tempted by tax savings tips, my notes on saving on business taxes are a sensible next read.
A plain example of how the two reports differ
Imagine a small café. Its profit and loss account for the year shows money taken at the till, the cost of coffee, milk and food, staff wages, rent, energy and the profit left at the end. Its balance sheet on the last day of the year shows the coffee machine and fridges it owns, cash in the bank, stock in the storeroom, the loan it took out to refurbish, and any tax or supplier bills still to pay.
The café could have a great year on the profit and loss account and still have a stretched balance sheet if the refurbishment loan is large. Or it could have a quiet year but a strong balance sheet because it's built up cash in previous years. That's why lenders and investors usually want to see both.
What lenders and buyers look for in these reports
- Steady or growing profit on the profit and loss account over several periods.
- Enough cash and short-term assets on the balance sheet to cover bills coming up.
- Sensible debt levels compared with what the business owns.
- Money owed by customers that's being collected on time.
- Clean, consistent bookkeeping that matches the bank statements.
If you're planning to borrow or sell the business one day, keeping both reports tidy now makes that process far less stressful later.
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Getting both reports from your bookkeeping
Modern accounting software builds both reports from the same transactions. Every sale, bill and bank movement you record updates the profit and loss account, the balance sheet or both. That's why keeping bookkeeping up to date matters so much: if transactions are missing or in the wrong category, both reports will be wrong in different ways.
- Reconcile your bank feeds every week.
- Record customer invoices and supplier bills as they happen.
- Check the balance sheet for old unpaid invoices that should be chased or written off.
- Run both reports at the end of each month and save a copy.
- Review them with your accountant at least once a year.
Ten minutes a week on bookkeeping saves hours at year end, and it means the reports you rely on are telling you the truth.
And if your business is very small, don't let the jargon put you off. Even a simple monthly look at what came in, what went out and what you owe will put you ahead of many owners who only see their figures once a year.
Reading your reports with an accountant
If you're not sure how to read your reports, ask your accountant to walk you through them once, using your own numbers. Ask what they look at first and what would worry them. That one conversation can change how you run the business.
This article is general information, not financial or tax advice, so check with an accountant or the official guidance for your own situation.
Frequently asked questions
What is the difference between a profit and loss account and a balance sheet?
A profit and loss account shows sales, costs and profit over a period. A balance sheet shows what the business owns, owes and is owed on a single date.
Do limited companies need both?
GOV.UK says statutory accounts must include a balance sheet and a profit and loss account, plus notes, and usually a director's report.
Is a profit and loss account the same as an income statement?
Yes. Income statement is another name for the profit and loss account.
Why can a profitable business run out of cash?
Profit isn't the same as cash. Money tied up in stock or unpaid customer invoices shows on the balance sheet, not as cash in the bank.
What does a balance sheet balance?
Assets equal liabilities plus equity. If they don't match, something has been recorded incorrectly.
How often should I look at these reports?
A monthly profit and loss is very useful, and a monthly or quarterly balance sheet check keeps debts and money owed in view.
