Profit/Loss Accounts

Profit/Loss Accounts

Every business wants to know the incomes earned and expenses incurred during a particular period, usually at the end of the year. Profit & Loss Account reflects the income and expenses of the business. It is a financial statement reflecting the outcome of business activities of an organization during an accounting period. The Profit & Loss Account reports the incomes and expenses directly related to an organization to measure the performance in terms of profit or loss. Profit & Loss Account is also known as P&L A/c, Profit & Loss Statement, Income Statement or Income and Expense Statement.

What is Profit & Loss Statement?

The Profit & Loss Statement is a crucial financial statement summarizing the costs, revenues and expenses incurred by a business during a specific period, usually a quarter or year. All the indirect expenses and incomes, including the gross profit/loss, are reported in the Profit & Loss Statement to arrive at the net profit or loss. It shows the company’s net profit or loss during a specific time for which it is prepared. This statement helps companies make informed decisions about their operations and track their financial performance.

Profit & Loss Statement/Account shows the profits/losses earned/incurred by a business for a month or a year. Companies use Profit & Loss Statement and others use “T Account” for these below mentioned reasons. Profit & Loss Statement/Account is prepared for two main reasons.

• To know the profits/losses earned/incurred by a business,
• Statutory requirements (Companies Act, Partnership Act or any other law)

Traditionally, there were two steps to know the profit/loss. It meant, the preparation of :

• Trading Account
• Profit & Loss Account

The trading account reflects the gross profit or loss of the business. Profit & Loss Account shows the net profit or loss earned by the company. Calculations in the Profit & Loss Account would be as follows:

• Add all revenue earned over the accounting period.
• Add all expenditures made throughout the accounting period.
• Subtract total expenses from total revenue to know the difference.
• If the value is positive, it represents profit; if it is negative, it represents a loss.

How to prepare Profit & Loss Statement?

Below is the process to prepare the Profit & Loss Statement:

• Prepare ledger accounts: An account statement must be prepared for each ledger from the journal book to determine the closing balance.
• Create trial balance: Trial balance summarizes all the ledger accounts. It lists every ledger account with the closing balance posted from the individual ledger accounts statement.
• Preparing trading and profit & loss statement: All the ledger accounts with the nature of the sales, purchase, indirect expenses, direct expense and income are posted to the Profit & Loss Statement.

Components of Profit & Loss Statements

The Profit & Loss Account consists of many components that record the expenses and income of the business under various categories, which are listed below:

Revenue/Income

The business’s income is classified into two main categories. The revenue from the primary business operations is recorded first, which includes the revenue generated in the normal course of business. The next category refers to the other income or the miscellaneous income of the business, which includes the income generated from the company's various investments, such as interest or dividend income.

Cost of Goods Sold

The Cost of Goods Sold (COGS) recorded in the Profit & Loss Statement includes the direct cost of operating like the labour cost, raw material cost or the direct overheads of the business related to the purchasing or manufacturing the goods. These expenses are deducted from the revenue to generate the business’s gross margin.

Operating Expenses

Operating expenses are the indirect expenses/costs involved in the production or manufacturing process of running a business. These expenses include administrative expenses like depreciation costs, employee costs, marketing and distribution costs, selling cost, research and development costs, etc.

Operating Profit

The operating profit is the positive balance from the gross margin after deducting the operating expenses. It is also called EBIT (Earnings Before Interest and Taxes). A positive operating margin assures the stakeholders and investors of the business’s profitability and solvency.

Net Income

The net income of a business is the net profit generated by the business after deducting all the operating and non-operating expenses, interest and taxes. It is the profit that is available for distribution to the shareholders. The earnings per share are also calculated based on the net profit or the business’s net income.

Different Formats of the Profit & Loss Account

Let us take you through different formats of the profit & loss account:

• Format for Sole Traders & Partnership Firms
• Format of P&L Account for Companies

Format for Sole Traders & Partnership Firms

No specific format of Profit & Loss Account is given for the sole traders and partnership firms. They can prepare the P&L Account in any form. However, it should reflect the gross profit & net profit separately.

Usually, these entities prefer “T shaped form” for preparing P&L account.

• T-shape Form T-shape form P&L account has two sides – Debit & Credit. Trading account is prepared first followed by Profit & Loss Statement.