How do Profit and Loss (P&L) Statement Work?
P&L statement also referred to as income statement, presents a summary of the revenues, costs, and expenses made by an organisation during a particular period. This is how P&L statements work:
1. Revenue Recognition: The identification of income is the first entry in P&L statements. This comprises revenue from any other sources in addition to those that result from the business’s main business activities (e.g., sales of goods or services).
2. Cost of Goods Sold (COGS): To determine the gross profit, the direct expenses related to the production of goods or services are deducted from the overall revenue. Expenses that are directly linked with the manufacture of a product, such as labour and basic materials, are included in COGS.
3. Gross Profit: Gross profit, which is the profit generated from the fundamental business operations of a company, is the third component. Determined by deducting cost of goods sold (COGS) from total revenue, it provides a fundamental evaluation of profitability before taking into account the operating expenses.
4. Operating Expenses: Operating expenses include a variety of expenses that are essential in the operation of the business. These include research and development costs, selling and business and administration expenses, and additional overheads. By deducting these expenses from the total profit, the operating profit is calculated.
5. Non-Operating Income and Expenses: This category includes non-operational items, which includes interest income, asset sale gains or losses, and other activities that are not considered main business activities. These items have an effect on the company’s final profit.
6. Profit Before Tax: The profit before taxes (PBT) is calculated by deducting non-operating expenses and total operating expenses from the operating profit. It signifies the profit generated prior to the deduction of income tax.
7. Income Tax Expense: This category includes both present and deferred income tax expenditures. A percentage of the company’s profits must be set aside to satisfy its tax obligations.
8. Net Loss or Profit (Net Profit): The net profit is the amount remaining after income tax expenses have been subtracted from the Profit before Tax. It signifies the total financial gain of the business over the chosen period. A negative result signifies a possible nett loss.
9. Analysis and Interpretation: The P&L statement is reviewed by various stakeholders, such as investors, management, and analysts, in order to examine the financial well-being of the organisation, trends in profitability, and the productivity of cost management strategies.
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