What is a Profit and Loss Statement? A Plain-English Guide for Dutch Entrepreneurs

The Profit and Loss Statement (Winst- en Verliesrekening) or Income Statement (the official English term) is the most used statement among financial reports. It answers the questions:

How did my business perform during the year?

Where does the profit or loss come from?

The Profit & Loss account explains – HOW – the Result (mentioned in my previous article about the Balance sheet) is achieved.

There is great flexibility in the split of this statement – essentially depending on the nature of the business the expenses may be split differently.

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The Revenue

This is the starting point of the Profit and Loss statement – this will be the total of all invoices that you have issued during the year (net of VAT).

According to the needs of your business – you may split different income streams – when you want to track these separately:

• By product family or type (Normal bikes or electric bikes)
• By activity that your business is offering, (Individual Coaching sessions, Key-note Speaker honorarium)
• Country (in NL, EU and the Rest of the world)

One note on VAT: Revenue is shown net of VAT because VAT is never your income – you collect it on behalf of the tax authority. The same logic doesn’t always apply to costs, though. If you use KOR (small business VAT exemption scheme) you cannot reclaim VAT on your purchases, so the VAT becomes a real, non-recoverable cost sitting inside your expense lines below. There are exclusions from VAT deduction for certain type of costs – in which case you may be able to include these in your expenses inclusive of VAT (see these cases in this article).

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The Nature of Expense Method

In the Nature of expense method – we group expenses according to what they were spent ON. Such as Raw materials, Purchased services, Employee costs, Depreciation, Rent, Transport and other operating expenses.

Example:

Revenue	€500,000
Materials	€120,000
External services	€60,000
Salaries	€180,000
Rent	€30,000
Depreciation	€20,000
Other expenses	€40,000
Profit	€50,000

This is often easier for service businesses, small companies and for bookkeeping and tax reporting.

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The Function of Expense Method

In the Function of expense method – we focus on what business activity does the expense support. Here the Cost of Sales, Selling expenses, Administrative expenses and R&D expenses (and more) can be differentiated.

Example:

Revenue	€500,000
Direct costs (cost of goods sold, subcontractors or direct client costs if those are invoiced to the client)	€250,000
Gross Profit	€250,000
Selling expenses	€100,000
Administrative expenses	€80,000
R&D expenses	€20,000
Operating Profit	€50,000

The salary of an employee is no longer ‘Employment cost’ but rather:

• factory employee >> cost of manufacturing or cost of goods
• sales manager >> Selling expenses
• office administrator >> Administrative expenses

Depreciation also doesn’t disappear under this method — it isn’t eliminated, just distributed across whichever function used the asset (e.g. depreciation on factory equipment sits within Direct Costs, while office equipment depreciation sits within Administrative expenses).

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Gross Profit

Gross Profit is what remains after the direct costs of producing or delivering a product or service have been deducted from Revenue. It shows whether the business is making money before considering administration, sales and financing costs.

In some service businesses, there may be very few direct costs. In those cases Revenue and Gross Profit can be (almost) identical. In these cases most expenses are indirect operating costs, such as marketing, software subscriptions, insurance and administration. If you pass the costs of subcontractors, purchased materials directly to the client, or incur client-specific costs, you will usually deduct these direct costs first, and show a lower Gross Profit.

This Gross Profit can be extremely useful when you are setting your Sale prices or Hourly rates.

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Operating Profit, Financing and Once off items

In both cases we are showing the core operation separately from other type of income and results – which may be related to:

• Financing cost (interest payments on business loans)
• Investment income: Interests, Dividends and Capital gains/losses (when selling shares in another company)

Additionally, once off items – such as selling a big asset (selling the office building) – would be reported either separately under ‘Other income and expenses’ or under the Operating income / cost, but highlighting these on a separate line.

The separation of these items helps us to reveal the real profitability of the underlying business without the impact of how we raised capital or made big, once-in-a-lifetime positive or negative impacts.

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Flexibility in the Detail

In each case companies are free to further detail the split of their income and expenses as the see fit – whatever serves best their own operation and business management.

For example – when I worked at Unilever – being reponsible for the European operation, I could see the Global results, but also a detailed P&L for Europe. And within Europe, I had a break-down by country, by product category (like hair care products and deodorants) and even by customer. In each of these sub-P&Ls I could see the total Revenue, the cost of goods, cost of advertising and indirect costs. That helped me to find out which product was the most profitable, which region was growing and where we did not spend enough on advertising. This detail helps the business not only to understand how and how much profit we are making, but also why results differ between products, regions or even customers.

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Tax

Last, but not least – we will want to know our Profit Before Tax, our Corporate Tax liability and the Profit After Tax.

A ZZP business itself does not pay Corporate tax. Instead, the profit becomes part of the entrepreneur’s personal income “winst uit onderneming”, which is reported in Box 1 of the income tax return.

For a BV – which is a separate legal entity – the Corporate tax (Vennotschapsbelasting) is paid by the company. In this case – we will also show the Tax and the Profit after tax in the P&L.

Non-profit organisations and churches often have different reporting obligations and typically call this statement the Staat van Baten en Lasten (Statement of Income and Expenditure). However, the same principles still apply: they must report their income, their expenses, and the resulting surplus or deficit for the year.

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Net Result — the link back to the Balance Sheet

After Corporate tax (for a BV) or alongside your personal income tax (for a ZZP business), what’s left is the Net Result — the actual bottom line of the Profit and Loss statement for the year.

This is the figure that connects the P&L back to the Balance Sheet: the Net Result for the year flows into Equity (Eigen Vermogen) on the Balance Sheet, increasing it in a profitable year and reducing it in a loss-making one. In other words, the P&L explains how your Equity changed during the year, while the Balance Sheet shows where it stands at a single point in time.

I explain how this connection works, with a worked example, in How the balance sheet and the profit and loss statement are connected.

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