June 22, 2024

What is the profit and loss statement?

A profit and loss statement (or income statement) is a financial statement that shows the profit of a company for a specific period. It summarizes the financial performance of the business for that time period and also shows how much revenue was generated, how much expenses were incurred, and what is left over for profit or loss. The profit and loss statement also shows how much cash was generated during this time period.

The profit and loss statement is also called as profit and loss account, statement of profit and loss, or even sometimes income statement.

The income statement provides information about the company’s sales revenue, expenses, and other costs associated with generating revenues over a period of time.

How Profit and loss statement is used?

If you search online you can find several profit and loss account examples however, none of them quite explain the how it all works in in detail. So we are going to do it for you now.

The preparation of profit and loss statements requires detailed analysis of all kinds of expenses. They should be broken down into categories such as fixed, variable, and non-cash expenses.

Fixed expenses are those which are not affected by sales volume. These include rent, electricity, wages and salaries, insurance premiums, depreciation on plant and equipment, etc.

Variable expenses are those which rise or fall depending on sales volume; therefore their level of expenditure will depend on the number of units sold during a given period.

Non-cash expenses such as depreciation on plant & equipment may or may not be recorded as part of operating expenses but are often included in the category “Other operating expenses” or “Other costs & expenses” when they don’t fit clearly into any other category.

In addition to analyzing profitability based on net income (profit), managers must also evaluate profitability based on return on assets (ROA). ROA is calculated by dividing net income by average total assets. The higher the ratio is for a given period (earnings before interest & taxes), the better is its performance compared to other businesses in its industry; this gives managers an opportunity to increase efficiency and make improvements in operations procedures.

Different types of profit and loss statements

Cash method

Cash is the cash flow that comes in and goes out of a business during a given period. This type of statement shows how much cash you have on hand at the start of the period and how much you withdraw from your bank account and other sources of money during the same time period. For every transaction the records show cash as liability whenever it is used for paying like paying off bills or liabilities. However, the record is seen as revenue when the cash is received or earned. The cash method is generally used to manage personal finances or for small businesses. This is because it is easy to manage and straightforward. So if you couple the cash method with an understanding of what is trial balance, you can pretty much handle all accounting requirements for a small business.

Accrual method

The accrual method of accounting records revenue when earned, not when received. The accrual principle also applies to expenses, which are recorded when they occur, not when they’re paid for by check or other payment methods.

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