Profit and Loss Statement Meaning, Importance, Types

Profit and Loss Statement Meaning, Importance, Types

A profit and loss (P&L) statement is a financial statement that summarises the revenues, costs, and expenses incurred during a given period, which is usually a quarter or fiscal year. 

These records reveal a company's ability or inability to generate profit through increased revenue, cost reductions, or both. 

P&L statements are frequently presented in cash or accrual format. 

Company managers and investors use P&L statements to assess a company's financial health.

What is the Function of Profit and Loss account(P&L) Statements

The balance sheet and cash flow statement, along with the profit and loss statement, is one of three financial statements that every public company issues on a quarterly and annual basis. 

It is frequently the most popular and common financial statement in a business plan because it shows how much profit or loss a company generates.

P&L statements are also known as :

  • Profit and loss statement
  • operational statement
  • Income or financial results statement
  • Profit and loss statement
  • Expense report
  • Profit and loss statement

The profit and loss or income declaration, like the financial statement, shows changes in accounts over a specific period. 

On the other hand, the balance sheet is a snapshot of the company's assets and liabilities at a single point in time. 

The income statement and cash flow statement must be compared because, under the accrual system of accounting, a company could log revenues and costs before cash increases in value.

This document takes the general format shown in the example below. 

It starts with a revenue entry, known as the top line. It subtracts the costs of doing business, which include the cost of goods, operating expenses, tax expenses, and interest expenses. 

The difference, referred to as the bottom line, is net income, also known as profit or earnings.

P&L Statement Comparison

It is critical to compare income statements from various accounting periods. 

This is because changes in revenues, operating costs, R&D spending, and net earnings over time are more significant than the numbers themselves. 

For example, a company's revenues may grow steadily, but its expenses may grow much faster.

Comparing one company's P&L statement to another in the same industry with a similar size can help investors evaluate a company's financial health even further. 

For example, this could reveal that one company is more efficient at managing expenses and has greater potential for growth than the other.

What is the Profit and loss account(P&L) Statement Types

As previously stated, a profit and loss statement can be prepared in one of two ways. 

There are two of them: the cash method and the accrual method.

Cash method:

The cash method, also known as the cash accounting method, is only used when cash enters and exits the business. 

This is a straightforward method that only accounts for money received or paid. 

When cash is received, a business records the transaction as revenue, and the transaction is recorded as a liability when cash is used to pay bills or liabilities. 

This method is commonly used by small businesses and individuals who want to manage their finances.

Accrual Method:

Revenue is recorded using the accrual accounting method as it is earned. 

It means that an accrual method company accounts for money that it expects to receive in the future. 

For example, a company that delivers a service or product to a customer records the revenue on its profit and loss statement even if it has yet to receive payment. 

Similarly, liabilities are accounted for even when no expenses have been paid.

Example of P&L Statement

Company XYZ ltd is in the textile industry, producing and selling various readymade garments on the market. 

The company's policy is to prepare a profit and loss statement every month and then one profit and loss statement at the end of the fiscal year.

In June 2019, the company generated $ 100,000 in revenue by selling garments, while the cost of goods sold was $ 60,000. 

In addition, the Company earns $ 9,000 from selling the waste material left over after making the garments and $ 4,000 in interest income.

On the expense side, the company spends $ 5,500 per month on-premises rent, $15,000 on factory worker wages, $ 7,700 on annual depreciation, and $ 9,000 on utility expenses.

Prepare the company's profit and loss statement for the month ending June 31, 2019.

Profit and Loss Account Statement

Particulars

Amount ($)

Amount($)

Revenues

   

Sales

100,000

 

Scrap Sales

9000

 

Interest Income

4000

113000

Total Revenues

   

Expenses

   

Cost of Goods Sold

60000

 

Rent

5500

 

Wages

15000

 

Depreciation

7700

 

Utilities

9000

 

Total Expenses (B)

 

97200

Net Income (A-B)

 

15800

Thus, for the month ending June 31, 2019, the company generated a net income of $15,800. 

The above Profit and Loss Statement for the company XYZ ltd is prepared using the Single-step Profit and Loss Statement approach, in which all expenses are listed in the statement in major broad categories without further subcategorization. 

It is simple and easy to create because a further division of the categories is not required, saving time.

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Conclusion

Concluding, the profit and loss statement summarises a company's revenues, costs, and expenses over a specific period. 

It is one of three financial statements issued quarterly and annually by public companies, the other two being a balance sheet and a cash flow statement. 

Investors and analysts use financial statements to assess a company's financial health and growth potential.

FAQs

1. What is the significance of profit and loss account (P&L) statements?

A profit and loss account(P&L) statement is one of three types of financial statements that businesses prepare. The balance sheet and cash flow statement are the other two. 

The purpose of the profit and loss statement is to show a company's revenues and expenses over a specific period, usually one fiscal year.

Investors and analysts can use this information to assess the company's profitability, frequently combining it with insights from the other two financial statements. 

For example, an investor could calculate a company's return on equity (ROE) by comparing its net income (as reported on the profit and loss statement) to its level of shareholder equity (as shown on the balance sheet).

2. What is the distinction between a profit and loss statement and a balance sheet?

A business's profit and loss statement show its income, expenses, and profitability over time. On the other hand, the balance sheet is a snapshot of the company's assets and liabilities as of a specific date. 

The balance sheet is typically presented as the last day of the company's fiscal year

Investors use the balance sheet to understand the company's financial strength by comparing the amount and quality of assets to liabilities.

3. Is it mandatory for all businesses to prepare profit and loss statements?

Profit and loss account statements and financial statements must be filed with the US Securities and Exchange Commission (SEC) by publicly traded companies so that investors can scrutinize them, analysts, and regulators. 

When preparing these statements, businesses must follow a set of rules and guidelines known as generally accepted accounting principles (GAAP).

4. Why Are P&L Statements Published?

P&L statements are made public for a variety of reasons. Many people, including accountants, economists, and investors, are fascinated by a company's inner financial workings. Because some companies are so large, even the owners may not have a complete understanding of all the company's financial movements without consulting the P&L. For all of these professionals, evaluating a company's financial strength entails taking a close look at total revenue, debt or leverage, additional investments, secondary operations, and tax burden.

These statements assist businesses in determining current performance in comparison to projections and developing future forecasts. They also compare performance to other companies in the same industry to identify unnecessary expenditures or areas for improvement.

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