“A manager’s guide to a simple profit and loss statement”
This is an era of Information Technology and there are sophisticated systems like ERP which will throw you the profit and loss statement for any period at just one click. But the method of finding profit is as old as money itself. Right from the curd vendor women in our villages who mark their sales in burnt charcoal to Reliance and Tatas, the ultimate goal is profit. In any business for that matter, profit is calculated. Only the methods differ. This article is meant to help the managers who are masters in their own domain but who are clueless about debit and credit.
Principles a non-finance manager should know before preparing a P&L statement:
- Cash generated is not the profit of the business. Cash flow statement is totally different from a P&L statement. A formal P&L statement does not consider cash flows. For example, you buy goods worth Rs. 1,000 from a vendor paying cash and sell it to a customer for Rs. 1,100. All this happens on 25th March. You give the customer a month’s time to pay his due. But you were asked to calculate the profit on 31st March. How much do you say?
It’s still Rs. 100 though the cash has not been received yet.
- The business should be treated as a person altogether different from the proprietor. So the transaction between the business and proprietor forms part of the P&L. To put it simply, while preparing the P&L of a business, consider the proprietor as a third person from whom you have got money and you must give it back at some point of time. This is why interest paid to the proprietor forms part of the expense side in the business’ P&L, whereas it is actually an income to the proprietor.
To start with, the majority of the businesses falls in either of these two categories: one is Sales and the other, Services. Preparing a P&L statement for a business of services is very simple. There will be service income and expenses paid to professionals. There will not be any goods involved.
The format of a traditional service-oriented business’s P&L
Income refers not to the cash received. It may also include the non-cash income (refer principle 1 above). All cash received is not income. For example, loan from a bank.
Now for the business involving goods. Before getting into that, let’s try answering this simple question. You are in the business of selling eggs. On 1st April, you have 10 eggs in hand which you bought paying Re. 1 each. You buy 100 more eggs during the year (Financial year) and you sold 90 eggs. Your standard selling price for eggs is Rs. 2 each. What is your profit for the period 1st April to 31st March?
If your answer is Rs. 90, you are a genius being a non-finance person.
Traditional format of P&L of a business involving goods
Opening and closing stock is the value of stock which you can find from the purchase invoices.
Sales is the sum of your billing to the customer.
Purchases are the sum of invoices that you received during the period from your vendors.
If you go by layman’s logic, you sold 90 eggs during the period and got (or will get) Rs. 180. You paid Rs. 90 for those eggs you sold. So your business generated a profit of Rs. 90. Profit is only for the goods sold. There cannot be profit without sales.
The mentioning of opening stock and closing stock in the statement is to arrive at the profit only on the goods sold.
Gross profit is the profit only from selling goods. Net profit is the real business profit. The above table extends below to find Net profit:
Disclaimer: This article is aimed at giving a rough idea on the concept of P&L and it does not in any manner recommend the format of the same which is governed by the Companies Act 1956.