A profit and loss statement is a document that keeps a company’s financial records over a period of time. It includes the company’s revenues through sales and expenses incurred at various stages of functioning. It therefore gives a clear picture of the net profit or loss of the company.
The statement is also called an expense sheet or an income statement, and is one of the most important financial documents along with the balance sheets and the statement of cash flows (cash flow statement.)
Profit and Loss statements are extremely helpful in finding out the scope for improvement and setting their future plan of action. For large businesses, you may need bookkeepers and accountants to do the job for you.
TERM CHECK:
Gross profit – is sales minus cost of sales. For example, say I sell a carpet for £100, and I buy the carpet for £50. My gross profit is £50.
Net profit – there are always a large number of additional business costs that cannot be attributed directly to any one particular sale, for example the business clothes I wear on multiple jobs, the marketing cost to get the customers in the first place, admin costs, the paper to send out the invoices and newsletters, the rent of the business property etc etc. When all these additional costs of doing business come off the gross profit, it gives you the net profit.
Profit and loss statements don’t just inform you about your net profit (or loss.) They also provide a good over view of your business performance too.
Isn’t that kinda important to know?
You can also use it to measure against your expected growth to make changes to facilitate improvement. In a way, profit and loss statements help you analyze your performance for faults and help you predict your future growth based on trends and forecasts. You can find out where you are spending more than required or which section is hampering profit generation. All these and many more aspects are extremely important in determining your company’s financial health. You can also benchmark your performance with the industry standards too.
This gives you crucial data about how your company can thrive and compete in the market with its current expenditure and sales generation.
There are some key components in a profit and loss statement.
Revenue is the total money generated from sales, dividends, interests, rentals, etc.
Cost of Goods Sold (COGS) takes many factors such as freight, import duty, labour, handling, purchase charges, etc. into account to calculate the total costs of sales.
Gross profit is the sum total of sales income minus direct costs
Net profit is only obtained after subtracting the total overall expenses from the gross profit.
Once you know these important terms, you can easily go through your income statement and understand many things without the help of an expert.
Reviewing a P+L statement is easy; you should start by checking all the numbers first by making sure all the calculations are correct. Mark all the places where the expenses have exceeded revenue generation and try to attribute reasons to them. Why has this happened? Did you buy expensive machinery, or take on new staff (these are often a drain on resources before they add to productivity)?
Make observations in trends or seasonal variations. There may also be variations based on factors such as more expenses after hiring more employees. Research why that particular factor is resulting in a negative income and try to find solutions to improve the situation, such as staff training so they can increase productivity and profits.
Analyse your income sources carefully, and think of what you can do to maximise growth from them. Similarly, identify the heaviest expenses and think of ways you can reduce them. Following these tips can make creating, understanding and maintaining profit and loss statements easy for you.
BALANCE SHEET
A balance sheet is a part of the financial statements prepared by a company. It is the summary of the final balances of a firm or entity. It is a document that summarizes a company’s total assets and liabilities held by the company on a particular date so is therefore a snap shot of the company at a particular moment in time, and it has its maximum relevance on the last day of the company’s accounting period.
The balance sheet is an important document for managers who have the work to sanction loans, and for people who deal with giving credits or invest in equity, as it is important for all creditors to be aware of the businesses’ assets, liabilities, shares or equity.
All this information can be found in a balance sheet.
The balance sheet can be prepared on a daily basis and is essential in determining the financial position of the firm. Balance sheets are also prepared in every accounting period.
