Significance of Profit and Loss Account and some guidelines

Profit and Loss Account is a statement of expenses and income and the net amount of these two elements is known as either profit or loss of that company. It is prepared to know the profit or loss of any business organization during a particular period of time. Normally, Profit and Loss Statements are prepared at the end of each accounting year. The accounting year as our accounting standards starts from the 1st April of each year and ends on 31st March of next year.

Importance of Profit and Loss Account

• Profit & Loss statements are required to be prepared under Companies Act rules and regulations.
• The functioning and achievements of your business are assessed with the help of this statement. You will come to know whether your business is running in profits or incurring losses through this statement. 
• And, this is the preliminary stage for preparing your Balance Sheet. 
• One should first arrive at the Profit or Loss figure before preparing the Balance Sheet of any company as that figure is to be shown in the assets or liability as the case may be.
• The Profit and Loss Statement is required to be submitted along with the Balance Sheet for filing your tax returns and for Income-Tax assessments.
• Banks demand this statement also along with Balance Sheet while sanctioning loans for business.

How to prepare Profit and Loss account

It is very simple to prepare a profit and loss statement. It is a summary of the expenses and incomes of your business to derive the net result. If your income side total is excess the difference will be profit. Otherwise, if expenditures total is excess, then the difference will be a loss to your business.

1. First, you need to balance all your accounts in the Main Ledger or General Ledger of your business accurately.
2. Then tally your Trial Balance.
3. With the help of your trial balance, you can easily prepare a profit and loss statement. Enter all expenses in the expenditure column and all income in the income column. The net result will give you either profit or loss of your business.
4. There are two types of preparation. One is horizontal P&L a/c and the other one is vertical P&L a/c.

Horizontal Profit and Loss account

              Income                                                   Expenditure

Sales                       5000000                        
                                                              Goods purchased            3750000

                                                              Freight/transportation         250000

                                                              Labour charges                    50000

                                                              Godown rent                       30000

                                    _______                                                 _________      

                                    5000000                                                  4080000                                                                                                      
                                                             Gross/Trading Profit           920000

                                         Staff salary                        180000

                                                             Electricity                            50000

                                                             stationery                             30000

                                                             package charges                  30000

                                        sales promotion                    30000

                                                            other expenses                     20000

                                                                                                      340000

                                                                                   
                                                         Profit before interest/depreciation 580000  

                                                             Interest on loans                      100000    

                                                             Depreciation of assets              180000

                                                                                                            280000
                                                             NET PROFIT                         300000    

The above is a sample format of profit and loss account prepared in horizontal format.

In a vertical format, you will start with sales income and below it, all the expenses are stated in the same manner as in above format. The three elements of Gross profit, Profit before Depreciation and Net profit will be calculated in the same manner and in the same column under income.

All expenses directly related to the production of goods are taken for calculating the Trading profit of the company. Then salaries and administrative expenses and sales promotion are taken to arrive at the net profit before interest and depreciation. Then, you can separately calculate profit after depreciation and profit after interest, if you want them separate, to get separate statistics for each element of cost.

It is customary to provide the figures of previous year also in profit and loss statement, to enable comparison of figures with previous achievements.