Investors look beyond the headline profit in a UK SME’s profit and loss account. They want to understand whether revenue is reliable, margins are sustainable, costs are complete and the business can turn its earnings into cash.
They also want to know how much of the reported performance is likely to continue.
As an accountant with an MBA and a lot of commercial accounting experience, I help UK small businesses prepare financial information for investment. My starting point is straightforward: can the founder explain the profit, support it with evidence and reconcile it to the rest of the accounts?
An attractive profit figure is a starting point. The work is establishing how much confidence an investor can place in it.
What does a profit and loss account tell an investor?
A profit and loss account, often called a P&L or income statement, shows revenue, costs and profit over a period.
For an investor, it helps answer several questions:
- Is the business growing, and what is driving that growth?
- How much does it cost to deliver the revenue?
- Are overheads appropriate for the size and stage of the business?
- Is profitability improving or deteriorating?
- How dependent is profit on particular customers, accounting judgements or exceptional items?
- What might sustainable profit look like under an appropriate management structure?
The emphasis varies. An investor assessing an early-stage SaaS business may accept current losses while examining its route to sustainable economics. An investor in an established service business may focus more heavily on maintainable earnings and cash generation.
In both cases, the figures need to be credible.
First, does the revenue stand up to scrutiny?
Revenue is the first figure I test because so much of the investment story depends on it.
I compare turnover with the sales ledger, contracts, VAT returns and bank receipts. I expect differences, but I want to understand and reconcile them.
VAT treatment, payment timing, credit notes, deferred income and accrued income can all explain why those sources do not show the same figure.
If the differences cannot be explained, I would resolve that before relying on the reported profit.
Has revenue been recognised in the right period?
An invoice does not, by itself, establish that revenue belongs in that month. Neither does a receipt into the bank.
For subscription and project businesses, I look closely at what has been delivered and how the accounting reflects the contractual obligations.
For example, cash collected upfront for a year of service will not necessarily be revenue earned immediately. Likewise, work performed before invoicing may require recognition before the invoice is raised, depending on the contract and applicable accounting requirements.
The distinction matters because bringing revenue forward can make current profit look stronger at the expense of a later period.
I want the founder to explain the treatment of deferred income, accrued income and work in progress, with supporting records.
How dependable is the revenue?
Two businesses with the same turnover can present very different risks.
One may have repeat customers, diversified income and established contracts. Another may depend heavily on a single customer or a small number of projects.
Prepare to explain:
- Recurring and one-off revenue.
- Revenue concentration by customer.
- Related-party sales and their commercial terms.
- Discounts, refunds and credit notes.
- Contract renewals and cancellations.
- The difference between recognised revenue, signed orders and pipeline.
That supporting information helps an investor assess how much of the current performance can reasonably underpin the forecast.
What do gross margins reveal?
Gross margin shows what remains from revenue after the costs classified as directly attributable to delivering it.
I look at the monthly trend and the margin by product, service or customer. The annual blended percentage can conceal important changes.
A falling margin needs explanation. So does a sudden improvement.
Is the movement commercial or accounting?
A margin change may reflect pricing, supplier costs, customer mix or delivery efficiency.
It may also reflect inconsistent accounting. Costs may have moved between cost of sales and overheads, been capitalised or remained unrecorded at the reporting date.
Moving a cost into overheads can improve gross margin without changing operating profit. Failing to record it can overstate both.
Before drawing conclusions, establish that the periods are comparable.
Is growth creating stronger economics?
My first checks are:
- Gross margin trends.
- Cash conversion.
- Customer acquisition costs and their payback period.
- Revenue quality.
- Delivery capacity.
- Profitability of newer customers compared with older customers.
Revenue growth can be attractive even while the business is investing ahead of returns. But the founder needs to show how that investment is expected to produce sustainable economics.
Falling margins are not automatically evidence of a failing business. They are a reason to investigate whether growth is coming from discounts, a lower-margin mix, temporary delivery costs or a structural weakness.
Are all the costs included?
Understated costs can make a P&L look impressive while leaving the business with obligations it still has to fund.
I look for missing accruals, incomplete payroll costs, unrealistic provisions and expenses recorded in the wrong place.
Questions worth asking include:
- Have employer’s National Insurance and pension contributions been included?
- Have bonuses and relevant holiday pay obligations been accounted for?
- Are bad debt allowances consistent with the aged debtor report?
- Has stock or work in progress been reviewed for recoverability?
- Is interest consistent with the borrowing shown on the balance sheet?
- Have business expenses paid personally by the owner been recorded correctly?
- Are capitalised costs supported by the applicable accounting criteria?
Capitalisation is not inherently inappropriate. Development, software and contract costs can qualify for recognition as assets. The investor will want to understand the policy, the evidence supporting it and its effect on profit.
What would it cost to replace the founder’s work?
Owner remuneration deserves particular attention.
A founder may take a modest salary and receive dividends instead. Dividends are distributions to shareholders, rather than an operating expense for the work the founder performs.
If that work is essential, an investor needs to understand its realistic ongoing cost.
Normalising owner remuneration therefore works in both directions. An unusually high salary may justify removing the excess. A below-market salary may require reducing adjusted profit to reflect an appropriate replacement cost.
Removing the founder’s salary entirely while assuming their work continues does not produce a credible view of sustainable earnings.
What adjustments to profit will investors accept?
An adjusted profit figure aims to explain underlying performance. Its usefulness depends on the quality of the adjustments.
ICAEW’s financial due diligence guidance identifies earnings quality, trading trends, the cost base and cash generation as core areas of review.
My test is whether an adjustment is evidenced, appropriate to its purpose, applied consistently and reconciled clearly.
Adjustments need evidence and commercial logic
Potential adjustments include:
- Owner remuneration brought to a realistic market rate.
- Genuine exceptional costs unlikely to recur in normal operations.
- Evidenced personal expenditure.
- Related-party charges adjusted to commercial terms.
- Exceptional income that does not reflect ongoing trading.
- Accounting corrections or policy alignment needed to compare periods.
These are different types of adjustment. Correcting an accounting error is different from removing an exceptional cost, and both differ from presenting a forecast saving.
Keep those distinctions visible.
I also apply a replacement test: if you remove a cost, what happens to the activity it supported? The business may still need someone, or something, to perform that function.
EBITDA needs a clear definition
EBITDA means earnings before interest, tax, depreciation and amortisation.
Further exclusions, such as share-based payments, impairments or exceptional costs, require separate explanation. They should not disappear into an undefined “EBITDA” figure.
Nor does a non-cash charge automatically become irrelevant to an investor. Its economic significance still needs to be considered.
Show the reported result, the calculation of EBITDA where used, and any additional adjustments separately.
Which adjustments would I challenge?
I would question:
- “One-off” recruitment, restructuring or legal costs that appear repeatedly.
- Marketing expenditure removed even though sales depend on it.
- Founder or family remuneration excluded despite substantive work being performed.
- Forecast savings presented as historical results.
- New revenue annualised without the full cost of delivering it.
- Recurring bad debts or stock losses described as exceptional.
- One-off losses removed while one-off gains remain.
Income such as grants, tax credits or insurance recoveries also needs individual assessment. Its accounting treatment, recurrence and relevance to ongoing trading matter; a label alone is not enough to decide whether it should be excluded.
If every adjustment improves profit, I look more closely. A credible schedule should be willing to show adjustments that reduce earnings too.
Why investors examine monthly results
An annual P&L can hide seasonality, deteriorating margins and unusual year-end entries.
I review monthly results alongside prior periods and budget, asking:
- When did the trend change?
- Was the movement expected?
- Does it reflect trading, timing or a correction?
- Has the same issue appeared before?
- What has management done about it?
A large month-twelve movement deserves investigation, although it does not automatically imply wrongdoing.
If the management accounts differ from the statutory accounts, provide a reconciliation. Investors should be able to follow the movement between the two.
Why the P&L must connect to cash and the balance sheet
A P&L cannot establish cash generation on its own.
Profit may rise while cash falls because customers have not paid, stock has increased, work remains unbilled or the business has funded capital expenditure. Debt repayments and tax payments also affect cash without necessarily matching the current period’s profit expense.
The task is to explain the difference.
I examine debtors, creditors, accruals, stock, work in progress, capitalised expenditure, director’s loans and tax liabilities.
Stretching suppliers or deferring tax can temporarily support the bank balance. It does not resolve weak cash generation.
What should a founder investigate when profit rises but cash conversion weakens?
I would work through the issue in this order:
- Test revenue recognition, capitalisation and missing costs.
- Break down margin changes by price, cost, mix and customer.
- Review collection times, disputed invoices and billing delays.
- Examine stock and work in progress.
- Check supplier terms and overdue liabilities.
- Identify capital expenditure and other cash movements.
- Connect the findings to the commercial decisions behind them.
For example, a decision to win larger contracts through discounts and longer payment terms can reduce margins and increase funding needs at the same time.
That is more useful to understand than treating each symptom as an isolated problem.
How should you answer an investor’s difficult questions?
A credible answer names the cause, quantifies it, explains the response and offers evidence.
The following examples are hypothetical.
Explaining a fall in gross margin
Suppose an investor asks why gross margin fell from 52% to 44%.
An unconvincing answer would be:
“We’ve been growing quickly and taking on bigger clients. It should normalise as we scale.”
That leaves the investor to work out what happened and why it should improve.
A stronger answer would be:
“Five of the eight percentage points relate to discounted enterprise contracts. The other three relate to contractor costs during a hiring gap. We have agreed renewal pricing on two contracts, which takes effect next quarter, and contractor spend has already fallen following recruitment. Here is the customer margin analysis, with the achieved results separated from the expected improvement.”
The explanation accepts responsibility and makes the forecast testable.
Explaining an adjustment to profit
Suppose adjusted profit includes £180,000 of proposed add-backs:
- £95,000 of fees associated with a specific restructure.
- £55,000 of founder remuneration above an evidenced market-rate replacement cost.
- £30,000 for a software migration.
The founder should explain each item and provide the supporting records.
If similar migration projects occur regularly, the final item is open to challenge. Accepting only £15,000 of that £30,000 add-back would reduce the proposed adjusted profit by £15,000. Rejecting it entirely would reduce it by £30,000.
Show those alternatives clearly. A disputed adjustment should not make the entire earnings figure impossible to follow.
What should you prepare before sharing your P&L?
I would prepare:
- Monthly P&Ls with prior-period and budget comparisons.
- A reconciliation between management and statutory accounts.
- Revenue and margin analysis by relevant business line or customer.
- Accounting policies for significant judgement areas.
- A line-by-line adjusted profit schedule with evidence references.
- A bridge from profit to cash.
- Short commentary explaining significant movements and management actions.
Where a problem has been identified, show the cause, the response and any early evidence of improvement. Keep achieved results separate from planned benefits.
Make it easy for investors to check your profit
My strongest advice is to resist presenting the most flattering number you can construct.
Present the number you can explain, reconcile and defend.
A credible P&L shows how the business earns money, what it costs to sustain those earnings and where management needs to act. A founder who understands the weaknesses and brings the supporting evidence makes it easier for an investor to move from questioning the figures to assessing the opportunity.
