Profit and Loss Account (P&L Account), or income statement, is a Final Account that records Sales Revenue, all costs and profits or losses of the business for a given period of time.
All companies must keep correct accounting records. They need to keep detailed records of purchases, sales and all the other financial transactions that happened in the particular quarter or year. These financial records of business transactions are needed to provide essential information to stakeholder groups both inside and outside the organization.
While Final Accounts must be produced at least once a year by all businesses, they are often produced for managers more frequently. Different stakeholder groups follow detailed and up-to-date accounts being kept as they need accounting information for decision making.
The information contained in Profit and Loss Account (P&L Account) can be used in a number of ways.
Advantages of Profit and Loss Account (P&L Account)
- Measures business performance. It can be used to measure performance over time. Ratio Analysis is used for this kind of detailed business analysis.
- Useful for making comparisons. The actual data about Sales Revenue, different types of costs and profits can be used to benchmark against competitors or check whether objectives were met.
- Can attract investors. Prospective investors will assess the level of profits before putting their money into a firm. They want to know how much reward they will receive for taking the risk.
- Helpful when making a loan application. Banks and other lenders will certainly check all the financial information in order to decide whether to lend money to the business or not.
However, there are several limitations to Profit and Loss Account (P&L Account). Let’s check them out as well.
Disadvantages of Profit and Loss Account (P&L Account)
- Cannot guarantee future success. Profit and Loss Account (P&L Account) shows only past performance of the business in the previous years. Although forecasts can be made based on historical data, there is absolutely no guarantee that the business will succeed in the future as well.
- ‘Window dressing’ can occur. Manipulation of Final Accounts happen because not everybody is as honest as we are. Many businesses always want to make their books look more attractive. Therefore, accountants might be asked to ‘cook the books’. While this kind of actions are illegal, there are also many actions that count as legal manipulation. Accountants can make Final Accounts look much more attractive without actually breaking any laws. This will please the investors. For example, a business might decide to sell some of its Fixed Assets at the end of the trading year just to boost the level of sales revenue making profits look bigger. Or, the firm can wait until the very early next year to purchase large order of raw materials to keep the costs for this year low and make profits look higher.
- No standardized format. While there are two main systems that set accounting standards and accounting principles such as GAAP and IFRS, there is no globally standardized format for producing Profit and Loss Account (P&L Account). Final Accounts will look differently in different countries. You can easily see that when comparing the profit or loss of different firms in different countries.
To sum up, profit and Loss Account (P&L Account) shows the profit or loss that is generated after all costs are accounted for. If the cost of production and expenses are higher than the sales revenue, then the business makes an overall loss. And clearly, a business cannot survive for long without making any actual profit.
