How do businesses calculate the amount of profit or loss made during a period?
I’m Thomas Harwood and Welcome to The Accounting Student, where we create free and short videos
so that you can learn about accounting.
Today’s video is looking at the second part of the income statement, which is the profit
and loss account.
Most companies are started with the purpose to make a profit and in many cases they do,
however, unfortunately some do make a loss.
The computation of profits and losses is questionably the most vital objective of the accounting
role with in a business.
This is why we have the income statement!
In our prior video on "Part One of The Income Statement” we found out that the income
statement, which is also known as the trading, profit and loss account, is a summary of the
revenue and expenses of a business.
And as a result, this can establish the level of profit or loss made in a given period.
The income statement is helpful to identify what profits or losses were made by the business
during a period and can help the business and its stakeholders carry out many tasks,
including…
Planning ahead the future periods activities and trading
Looking at whether the business is capable of acquiring loans from banks and other financial
institutions Providing information on the business performance
to potential business partners and those who might invest in the future
and being able to calculate the tax to be paid on the trading profits
The income statement can be broken down simply into two main sections and they are the trading
account and the profit and loss account.
In this video we will look at the second part which is the profit and loss account section.
If you missed the first part of the income statement where we looked at the trading account
section, the link is in the description below.
The profit and loss account computes the net profit of the business for the period.
The net profit is described simply as the amount left of the gross profit after all
other expenses have been deducted.
The profit and loss account section of the income statement deducts all the expenses
related to running the business away from the gross profit which was calculated in the
trading account section.
It is important that these costs do not include the costs relating to the cost of goods sold
as these have already been included in the trading account section and subtracted to
get to the gross profit.
And then any one-off revenues are added to this sum to give the net profit.
Now let’s have a look at how this would be laid out…
First, we have the gross profit amount from the trading account section.
We then add all the other incomes and revenues to the gross profit value. This could be anything
ranging from the rent received by the businesses tenants to the discounts received from the
businesses suppliers.
Then we take away all the other expenses used in the period other than the ones that have
already been included in the cost of goods sold.
In this example, the other expenses include rent, insurance, light and heat expenses and
bad debts.
As a result, this gives us the net profit. However, where the costs used up exceed the
gross profit plus the other revenue this results in the business having a net loss.
The net profit is an important measure of the businesses performance and to see how
efficient they are at managing their operating costs.
So that was the second part of explaining the income statement, its purpose and the
profit and loss account section. If you enjoyed it, press the like button.
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Thanks for watching we’ll see you next time.