Variable Costs and Fixed Costs

All the costs faced by companies can be broken into two main categories:
fixed costs and variable costs.

Fixed costs are costs that are independent of output. These remain constant
throughout the relevant range and are usually considered sunk for the
relevant range (not relevant to output decisions). Fixed costs often include
rent, buildings, machinery, etc.

Variable costs are costs that vary with output. Generally variable costs
increase at a constant rate relative to labor and capital. Variable costs may
include wages, utilities, materials used in production, etc.

In accounting they also often refer to mixed costs. These are simply costs that
are part fixed and part variable. An example could be electricity--electricity
usage may increase with production but if nothing is produced a factory still
may require a certain amount of power just to maintain itself.
What does a profit and loss account include?

A profit and loss account will include your credits (which includes turnover and other income) and
deduct your debits (which includes allowances, cost of sales and overheads). These are used to find
your bottom line figure – either your net profit or your net loss.

What is a profit and loss account used for?

The profits shown in your profit and loss account are used to calculate both income tax and
corporation tax. Failure to file either of these correctly can result in you paying added interest and
penalties, so it’s important to get this report right.

The P&L account takes revenues into account for a specific period. It also records any expenses or
costs incurred by these revenues, such as depreciation and taxes.

This can be used show investors and other interested parties whether or not the company made
money during the period being reported.

Profit and loss account terms explained

What is net income? This is your income minus the cost of goods sold, expenses and taxes.

What is gross profit? This is your total revenue / sales, minus the cost of those goods sold.

What is operating profit? This is the profit you have after operating expenses (like rent) are deducted
from gross profit. It doesn’t include interest or tax deductions.
What is net profit? This is your actual profit. It’s the amount you’re left with after remaining working
expenses are deducted from gross profit.

Calculating net profit

To calculate net profit, follow this path:

1. Deduct discounts and allowances from your gross income (excluding VAT) to get your net
income.
2. Deduct the cost of sales from your net incomes to find your gross profit.
3. Deduct overheads from your gross profit to get your operating profit.
4. Deduct any other expenses from your operating profit (plus any other income) to find your
profit before tax.
5. Deduct tax to reach your net profit or net loss.