Even if we may not know it, we almost always use accounting in our daily life! Every time we create a budget or plan our expenditure, we end up using accounting principles either unintentionally or intentionally. Every time we receive our paycheck, and we calculate our spending to determine our savings, we are creating an income statement for ourselves. Similarly, on a broader scale, a company prepares an income statement outlining all forms of income and expenditure of that company.
A company or business uses some financial statements to record and show the financial performance of the company. The profit and loss statement, also known as the income statement. Is a financial statement that exhibits a company’s revenues and expenses, thus explain the company’s profit or loss. Like the cash flow statement, profit and loss statements usually represent information that has accumulated over a certain period, as opposed to balance sheets, which represent a singular moment.
The profit and loss accounts of a business tell investors and stakeholders how the revenues are converted into net profit or net income. And how expenses had contributed to the reduction of profits. It allows investors and stakeholders to make important decisions regarding the business. Since profit and loss statements are issued quarterly and annually, it also allows managers to compare the business’s financial performances every 3 months, and take looks at the business in detail.
The Key to Managing Finances
Types of Profit and Loss Statements
Generally, there are two types of income statements. The first is the pro forma profit and loss statement, and it refers to the profit and loss statement that is created initially when starting a new business. Every business requires a pro forma income statement when applying for funding. Pro forma means to project into the future, and that is literally what this statement does. The pro forma profit and loss account projects all expenses and revenues of the business based on existing data such as market competition and market size.
The other, and the more common type of profit and loss statement, is the periodic profit and loss statement. This is the review of revenues gained and expenses incurred by a business within a certain period – usually every quarter.
The preparation of a periodic profit and loss statement allows a business to compare its profits in different quarters. Pinpoint areas to minimize expenses and determine the net profit of the company, which in turn is used to calculate the taxes payable to the government.
The Components of a Profit and Loss Statement
A profit and loss statement usually consists of three key components: revenues, expenses, and profit or loss. Revenues refer to all forms of cash inflows and reception of assets of a company during a certain period. The revenue or the income earned can comprise the production of a good or provision of a service, accounts receivable and other incomes such as rent.
It also includes any income that is earned from intellectual property such as patents and copyrights. And the unusual incomes such as the sale of a fixed asset like a vehicle. In the broader sense, the revenues of a business consist of the money earned by the business due to the sales of a product or service.
On the other hand, expenses refer to all forms of cash outflows and loss of assets in a company in the same period. Expenses can differ in several ways and can be quite diverse in their categories. Expenses incurred by a business can include direct costs regarding the production of the good or service. Often referred to as the cost of goods sold or the cost of sales. This includes the cost of raw materials, labor, equipment, packaging and other forms of manufacturing costs that incur during production.
The expenses section also includes costs that incur after the production of a good or service is complete. This includes sales expenses such as expenses due to advertising and marketing, salaries of sales personnel, rent of storage units and shops, and expenses due to traveling and sales equipment. The profit and loss account also takes into account operational and administrative expenses such as salaries, rent, utility bills, insurance, legal fees, stationeries, food, petty cash, etc.
In addition to this, depreciation of fixed assets such as office space, vehicles and furniture and cost of research and development are considered when making up the profit and loss statement. The expenses section also covers losses such as foreign exchange losses, and taxes payable to government agencies.
Once the revenues and expenses have been calculated, all the expenses incurred by the company can be subtracted from the revenue to determine the company’s net profit or loss. Total revenue greater than total expenses will result in a net profit. Whereas total expenses greater than total revenue will cause a net loss.
How To Prepare a Profit and Loss Statement
To prepare an income statement for a company, several documents would be required. There would need to be a record of all sources of income by the company that has arisen from the sale of goods and services, and other sources such as rent and sale of assets. This can come in various forms – cash, bank account transfers, credit card or other methods of digital payment.
A business would also require information about all transactions that have occurred within that time – directly by cash or through banks. Thus a bank statement would be a useful document to have in preparing an income statement. It is also recommended to store a record of all cash transactions, or receipts, as they are as important to the business as a bank or digital method of payment.
Thus the income statement is one of the most significant financial documents. That represents a company’s past, present and future. An income statement summarizes all transactions of the company. And this plays a key role in determining the profit of the company, and therefore the company’s growth.