In order to analyze the performance of an SME and thus be able to compare it with other companies or with previous years, it is important to establish an account of its expenses and income.
Profit and loss accounts, produced at regular intervals, allow SMEs to evaluate their economic performance. These can then be used by various internal or external stakeholders, such as management teams for the proper administration of the company, investors, or banks regarding credit requests for example.
A profit and loss account (which is also known as an income statement) allows a company to establish whether its operations, over a given period of time (monthly, quarterly, annually), has generated profits or losses.
To do this, the account is divided into two main sections: income and expenses. In general, sales of goods and services, or other operational incomes (e.g. rental income or provision of staff), constitute the most important incomes. On the other hand, purchases, staff salaries and operating costs (e.g. rents) make up the major part of expenses.
The year-end accounts (i.e. the difference between incomes and expenses) constitute the outcome for the accounting period. It can be a profit or a loss.
The profit and loss account is part of the annual accounts (the financial statements of the individual entity) of a company. They also include the balance sheet and the notes to the accounts. These accounts are mandatory and must "present the economic position of the undertaking in such a manner that third parties can make a reliable assessment of the same" according to article 958 of The Code of Obligations (CO).
The minimum structure of the income statement is defined in article 959b CO. By law, two options are possible:
- The period-based accounting method (comprising a minimum of eleven items as defined in paragraph 2),
- The cost of sales method (constituting at least eight items, as described in paragraph 3).
The most common form of accounting is the period-based method.
Multi-step profit and loss account
Presented as a table (or list), the profit and loss account can be broken down into several steps or levels, with interim results for each.
The two-step income statement, for example, is commonly used by companies although it is not required by law. It separates the so-called "operating" items and transactions from the so-called "non-operating" items.
- The first tier shows variable expenses and income related to goods (such as purchases of goods, staff costs, rental charges and depreciation, against sales of goods and interest incomes). This part of the table ends with an interim balance called "operating profits".
- The second tier includes neutral expenses and incomes (such as property charges, extraordinary expenses, and direct taxes, versus extraordinary income). This last part of the table ends with the "company’s income statement".
Other tiers can also be inserted, adding different layers of complexity, as well as additional information (such as Earnings before interest and taxes).
Sources: Swiss Code of Obligations, Almanac EXPERTsuisse, BetterStudy blog, Bexio website (15 July 2021)