Lesson ID 381011
Version 04/30062022
UNDERSTANDING PROFIT AND LOSS STATEMENT
1. Introduction
The Profit & Loss Statement also called the Income Statement is one of the three primary financial
statements, alongside the Balance Sheet and the Cash Flow Statement. Profit & loss statement represents
income generation capacity of a business / entity over a period of time. The Profit & Loss statement shows a
company’s ability to generate sales, manage expenses and create profits. It is prepared based on accounting
principles that include revenue recognition, revenue matching and revenue accruals.
The basic equation for a profit and loss statement is: Revenues – Expenses = Profit (+ve) / Loss (-ve)
2. Accounting terms
a. Net sales = Gross sales – (Customer discounts, returns, and allowances)
b. Gross profit = Net sales – Cost of goods sold
c. Operating profit = Gross profit – Total operating expenses
d. Net profit = Operating profit – Taxes – Interest
e. Net profit = Net sales – Cost of goods sold – Operating expense – Taxes – Interest
3. Items included in the Profit & Loss statement
The items included in the profit and loss statement follows:
a. Revenue: The amount of money a business takes in during a reporting period.
b. Expenses: The amount of money a business spends during a reporting period.
c. Costs of goods sold (COGS): The cost of component parts of what it takes to make/sell whatever it is,
the business sells.
d. Gross profit: Total revenue less COGS.
e. Operating income: Gross profit less operating expenses.
f. Income before taxes: Operating income less non-operating expenses.
g. Net income: Income before taxes less taxes.
h. Depreciation: The extent to which assets (for example, aging equipment) have lost value over time.
i. EBITDA: Earnings before interest, taxes, depreciation and amortization.
j. Earnings per share:
Net Income – Preferred stock dividends
Earnings per share = -------------------------------------------------------------------
Weighted average of common stock shares outstanding
Types of income sources and expenditure:
Income Expenditure
Sales Cost of Goods Sold
Revenue Salaries
Interest income Insurance
Rental income Taxes
Fees for services Rent
Interest on business loans
Let us take few examples:
a) Profit and Loss Statement of a trading business for the period ending 31st December 2020:
Sales ₹2,00,000
Opening Inventories ₹25,000
Purchases ₹1,70,000
Closing Inventories ₹75,000
Cost of Goods Sold Opening Inventories + Purchases - Closing Inventories
₹25,000 + ₹1,70,000 - ₹75,000 = ₹1,20,000
Gross Profit Sales – Cost of Goods Sold
₹2,00,000 - ₹1,20,000 = ₹80,000
Rent Received ₹20,000
Interest Received ₹500
Other Income Rent Received + Interest Received
₹20,000 + ₹500 = ₹20,500
Salaries ₹16,000
Telephone & Internet ₹10,000
Water & Electricity ₹7,300
Property Rates and Taxes ₹3,000
Insurance ₹2,500
Advertising Costs ₹14,000
Stationery ₹654
Bank Charges ₹906
Income Tax Expense ₹6,700
Other Expenses Salaries + Telephone & Internet + Water & Electricity + Property Rates and
Taxes + Insurance + Advertising Costs + Stationery + Bank Charges + Income
Tax Expense
₹16,000 + ₹10,000 + ₹7,300 + ₹3,000 + ₹2,500 + ₹14,000 + ₹654 + ₹906 +
₹6,700 = ₹61,060
Net Profit Gross Profit + Other Income - Other Expenses
₹80,000 + ₹20,500 - ₹61,060 = ₹39,440
b) Profit and Loss Statement of a manufacturing business for the period ending 31st December 2020:
Sales ₹2,00,000
Opening Finished Goods ₹25,000
Cost of Finished Goods ₹1,70,000
Manufactured this year
Closing Finished Goods ₹75,000
Cost of Goods Sold Opening Inventories + Purchases - Closing Inventories
₹25,000 + ₹1,70,000 - ₹75,000 = ₹1,20,000
Gross Profit Sales – Cost of Goods Sold
₹2,00,000 - ₹1,20,000 = ₹80,000
Rent Received ₹20,000
Interest Received ₹500
Other Income Rent Received + Interest Received
₹20,000 + ₹500 = ₹20,500
Salaries of Office Staff ₹16,000
Telephone & Internet ₹10,000
Water & Electricity of Office ₹7,300
Building
Property Rates and Taxes of ₹3,000
Office Building
Insurance of Office Building ₹2,500
Advertising Costs ₹14,000
Stationery ₹654
Bank Charges ₹906
Income Tax Expense ₹6,700
Other Expenses Salaries + Telephone & Internet + Water & Electricity + Property Rates and
Taxes + Insurance + Advertising Costs + Stationery + Bank Charges + Income
Tax Expense
₹16,000 + ₹10,000 + ₹7,300 + ₹3,000 + ₹2,500 + ₹14,000 + ₹654 + ₹906 +
₹6,700 = ₹61,060
Net Profit Gross Profit + Other Income - Other Expenses
₹80,000 + ₹20,500 - ₹61,060 = ₹39,440
Unlike trading businesses, manufacturing businesses do not buy products at a low price and sell at a higher price.
Instead manufacturing businesses make products, which they then sell.
4. Schedules in Bank’s Profit and Loss Statement
Profit and Loss Statement is divided into:
(1) Income;
(2) Expenditure;
(3) Profit and Loss;
(4) Appropriation, represented by schedules as under
Schedule XIII Income Includes:
(1) Interest Earned:
(i) Interest, Discounts on advance and bills;
(ii) Income on investment;
(iii) Interest on balance with RBI.
(2) Others. It is the first item under this head.
Schedule XIV Other Incomes Includes:
(1) Commission, Exchange and Brokerage
(2) Profit on Sale of Investment;
(3) Profit on Revaluation of Investments;
(4) Profit on Sale of Land etc.
(5) Profit on exchange transactions.
(6) Income from dividend.
Schedule XV Interest Expended Includes:
(1) Interest on Deposits;
(2) Interest on RBI Deposit;
(3) Deposit of Others
Schedule XVI Operating Expenses Includes:
All revenue expenditures and provisions, viz. Rent, Taxes and
Lighting, Salaries, Wages, Depreciation, Law charges etc. Provision
for Bad Debt, Provision for Contingences, etc.
Thus, Profit and Loss statement will present the net result of the operation. This statement deals with the expenses
and incomes of the current year, i.e. if incomes exceed expense, this is profit, and vice versa in the opposite case.
Only appropriation items will appear in this account viz, amount transferred to General Reserve or Statutory
Reserve or Proposed Dividend etc. and the balance will appear in the Liability side of the Balance Sheet.
5. Advantages and Disadvantages of Profit and Loss Statement
Advantages Offers a glimpse at revenue information for the company.
Allows for investor analysis.
Tracks the performance of a company.
Used as a tool for forecasting.
Makes tax reporting responsibilities much easier.
A tool that lenders use for future financing opportunities.
Measures the success or failure of specific budget areas.
Allows you to identify potential competitive advantages.
Provides an overview of cash flows.
Disadvantages Can misrepresent the value of the company.
Does not evaluate non-revenue factors for success.
A report that is generated very frequently.
Might not report true costs.
Can be filled with numerous assumptions instead of facts.
Might not always provide useful information.
6. Importance of Profit and Loss statement
All organizations require to produce income to remain in business and that makes the basic P&L. Revenues are
utilized to pay costs, interest payments on the debt, and taxes. After all expenses of working together are paid, the
excess sum is called net income. Net income is accessible to investors, the organization often save these profits for
the future ventures as opposed to delivering out profits. Organizations do not generally have a positive net income
toward the end of a P&L. On the off chance that an organization is enduring a “loss”, this means that it is spending
more than it earns (otherwise called being ‘in the red’).
