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Understanding Profit and Loss Account

BY: Vivek SHARMA | Category: Finance | Submitted: 2011-04-03 18:27:50
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Article Summary: "The article is an attempt to explain significance of profit and loss account of a company. The profit account and the loss account are a very critical indicator of performance for a given period as it measures how the company has done in terms of profitability. .."


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A company is an artificial person created by law. A company is supposed to have perpetual existence. During the process of its existence, a company's performance is periodically measured by statements of 1) Balance Sheet, 2) Cash Flow Statement and 3) Profit and Loss Account. Out of this, Profit and Loss Account is a very critical indicator of performance for a given period as it measures how the company has done in terms of profitability. For various stakeholders of business like shareholders, customers, employees etc. profitability of a company is one of the key indicators how was the performance of business for a given period.

The profit and loss account also known as income statement, shows how the performance of a company has been at various levels such

1) Gross Profit
2) Operating Profit
3) Profit before Interest and Tax
4) Profit before Tax
5) Profit after Tax.

Gross Profit is the first level of profit determination. This is identified using Sales minus the cost of goods sold (COGS). Cost of goods sold includes direct costs attributable to the production of the goods which are sold by a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good.

After gross profit has been identified from P and L account, operating profit is determined. To find out operating profit, operating expenses from gross profit is reduce. The operating expenses include expense such as administrative expenses, general expenses, selling and distribution expenses, lease rent, depreciation, write off etc. The operating profit is also know as PBIT( Profit before Interest and Tax). Operating profit is used to identify operating profit margin which is a relationship between sales and operating profit.

The next step in profit determination is called as earning before tax or PBT.PBT is pre-tax income of a company. This is the income on which a company pays tax to the government. After PBT, Profit after Tax is identified. PAT is the final value of profit of a company. Profit after tax is the amount that is available to the shareholders for distribution. A company distributes a part of its profit to its shareholders and retains remaining part into business. The part of profit that is given to the shareholders is called as dividend. The other part which is retained in the business is used for the purpose of future growth by the companies. The retained earnings of the business forms part of reserves and surplus.

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