Rules
Part of Building clear profit and loss forms
Profit and loss forms mistakes: symptom guide
Profit and loss forms mistakes, organized by symptom: see why profit and cash differ, revenue gets overstated, periods mislead, and circulated forms change.
Profit and loss forms mistakes rarely announce themselves: you spot a number that looks wrong, then work backward from it. In a profit and loss form, this page is organized by symptom: the thing you notice, the mistake that usually produced it, and the fix.
The classification error, direct versus operating, is covered in the profit and loss overview and is not repeated here. These are the others.
What to take away
- "Profitable on paper, no cash in the bank" is nearly always a form that omits things which are not expenses but still leave the account.
- A margin that swings month to month is a cut-off problem before it is a business problem.
- Two versions of the same month that disagree mean the form has no version stamp.
Symptom to cause
| What you notice | Usual mistake | Where to look |
|---|---|---|
| Healthy net profit, empty bank account | Loan principal, equipment purchases, owner's drawings, or tax payments are not on the form, and were never going to be | Bank statement lines not in any category |
| Gross margin swings from month to month | Revenue and its direct costs landing in different months | Invoice dates against supplier bill dates |
| Revenue looks higher than what you sold | Sales tax collected on behalf of an authority counted as income, or deposits counted before delivery | Revenue line against invoiced net figures |
| A single month's expenses jump | An annual bill booked in one month, or a one-off inside operating | The month's largest lines |
| Last month's form now shows different numbers | Late transactions posted into a circulated period | The audit trail, if there is one |
| A quarter looks worse than the one before | Periods of different length compared, or a seasonal business compared to the previous quarter rather than the same quarter last year | The header dates |
| The business looks more profitable than you feel | The owner's own pay is missing | The salaries line |
Each in more detail.
One month worked through
The figures below are illustrative and round, chosen so the arithmetic is easy to follow. They are not a benchmark for any trade.
| Item | Amount |
|---|---|
| Invoiced sales, net of sales tax | $40,000 |
| Sales tax collected at 6 percent | $2,400 |
| Cash in from invoices | $42,400 |
| Customer deposit, work not started | $5,000 |
The month's invoices came to $40,000 net of sales tax, plus $2,400 sales tax collected at 6 percent, so $42,400 reached the bank. A customer also paid a $5,000 deposit for work starting next month.
A form that reads $47,400 as revenue has counted the $2,400 sales tax and the $5,000 deposit as income. Revenue is $40,000. The sales tax sits in a liability account until it is remitted, and the deposit is a liability until the work is done.
Cash tells a third story. A loan repayment of $1,500 left the account, of which $400 was interest and $1,100 principal. The form shows the $400 as an expense. It cannot show the $1,100, which is why a profitable month can end with less cash in it.
Profit without cash
The most common complaint from anyone reading their first form. The form is often right. It shows the profit the operation earned. It does not show, and should not show, several things that took money out of the account:
Cash out, not on form
- Loan principal repayments
- Equipment lasting over a year
- Owner's drawings
- Tax on last year's profit
- Stock bought, not yet sold
- Loan principal repayments.
- Equipment and other capital purchases.
- Owner's drawings or distributions.
- Tax payments, including sales tax remitted and estimated income tax.
- Growth in inventory or receivables, which ties up cash without booking an expense.
The fix is not to force these onto the form. It is to read the form next to a cash view, and to stop expecting one document to do both jobs.
Cut-off errors
Revenue recognized in March, the subcontractor's bill for that work booked in April. March looks brilliant; April looks terrible; the quarter is fine. Nobody can price anything from it.
Same job, three months
- MarchRevenue recognized
- AprilSubcontractor bill booked
- QuarterResult looks fine
Cut-off is the discipline of putting revenue and the cost of earning it in the same period. On an accrual basis that means accruing the cost when the work happened, even if the bill arrives later. On a cash basis the swing is inherent, and the answer is to read a longer period.
Either way, decide the rule and apply it the same way every month. A quote accepted in one month, delivered in the next, and invoiced in a third is the ordinary case, and the form needs a rule for it.
Revenue that is not yours
Two ways revenue gets overstated.
Is it really revenue?
Does the revenue line equal gross invoices?
Check for sales tax inside
Check deposits and prepayments
Sales tax or similar amounts collected from customers and passed to an authority are not income, if you are registered to collect them. Whether you are registered, and how to record those amounts, depends on your registration. Ask your accountant and your tax authority.
For a US business, that authority is the state department of revenue or taxation that issued your sales tax permit. It publishes what has to appear on the return and in your records.
The UK's rules on VAT record keeping show the kind of separate record such a scheme usually demands. But if your revenue line equals the gross total of your invoices, check.
Deposits and prepayments are money received before the work is done. On an accrual basis they are a liability until earned. Counting them as revenue on receipt makes a strong month out of a full order book, and a weak month out of the delivery.
Annual bills booked in one month
An annual insurance premium, a yearly software license, or a rent quarter paid in advance, booked in the month paid, each makes that month look expensive and the other eleven cheap.
Lumpy month, spread cost
Booked in month paid
- Insurance premium
- One month heavy
- Software license
- One month heavy
- Rent quarter
- One month heavy
Spread across months
- Insurance premium
- Twelve months even
- Software license
- Twelve months even
- Rent quarter
- Three months even
Spread each across the months it covers. On a cash basis, at least flag it so nobody reads the lump as a trend. A genuine one-off belongs below operating profit, not inside a category it will distort.
The form that changed after it was sent
You circulated March's form on the fifth of April. Three supplier bills dated March arrived on the ninth. The system posted them into March. Now March's form says something different from the one everybody saw.
Stop the form changing
- Add a version stamp with date produced
- Lock the period once circulated
- Post late items to next open period
- Note the late item on the new form
The fix has three parts: a version stamp with the date produced, a period lock once a form has been circulated, and a rule for late items. That rule usually means posting them into the next open period with a note. The version stamp matters most, because it turns "which one is right?" into "which one is later?"
Comparing unlike periods
A five-week month against a four-week one. A quarter with a holiday against one without. This quarter against last quarter in a business whose revenue arrives in one season. Each comparison is arithmetically valid and tells you nothing.
Compare like with like
Avoid
- Five-week month
- Same month last year
- Quarter with holiday
- Same quarter last year
- This quarter vs last
- Rolling twelve months
Use instead
- Five-week month
- Quarter with holiday
- This quarter vs last
Compare like with like: this month against the same month last year, and a rolling twelve months against the previous twelve. To check whether a period's revenue is a timing effect, count the invoices and look at their dates.
Unpaid owner labour
A business where the owner does the work and pays themselves irregularly, or not at all, shows a profit that includes the value of the owner's labor. That profit is not available to anyone else who might run the business, and not comparable to any other business.
Estimate the wage-equivalent in three steps. Find the market rate for the role in your metro area, using the Bureau of Labor Statistics Occupational Employment and Wage Statistics series, which is public and free.
Multiply that rate by the hours the owner works. Then add the employer's share of payroll taxes, typically 7.65 percent for Social Security and Medicare in the United States, plus benefits the role would carry.
Put a line in for what the role would cost to fill, at least as a memo item, and let the form show the profit the business makes on top of a wage. How the owner's pay is treated for reporting depends on the structure and is a question for your accountant.
If you pay yourself through payroll, the line items are simple: an officer's compensation or owner's wages line inside operating expenses, plus a payroll taxes line. If you take drawings instead, keep the wage equivalent as a memo deduction below net profit and label it, so nobody reads the memo figure as a booked expense.
A short diagnostic pass
When a number looks wrong, in this order:
- Read the header. Period, basis, version date.
- Compare the revenue line to what was invoiced or collected. If they differ, find out why before touching anything else.
- Look at the three largest lines in the month. Is any of them annual, one-off, or misdated?
- Look for what is missing from the form rather than what is on it.
- Only then question whether the business has changed.
Most of the time the answer arrives at step three. Where a form is reviewed in a monthly management meeting, that pass is worth running before the meeting rather than during it.
If you want the blank page rather than the diagnosis, Company Form Templates publishes printable profit and loss forms. Check that the version you print carries the sales tax, deposit and owner's pay lines.
