Among the analyses that can be applied to financial statements, the profit and loss statement is one of the most important. It is a form through which we can obtain a great deal of information about the company. This information can apply to such diverse things as optimizing expenses, maximizing income, improving the profit ratio, etc.
As with all business accounting tools, this type of analysis is usually included in the most comprehensive software nowadays. However, it is useful to know how it works and the basis on which profit and loss statements are created.
Why is it important to know the profit and loss statements?
The first thing to do is to situate this concept: a profit and loss statement is a financial report reflecting the company’s income and expenses for a given period. Payments will also include fixed costs.
This financial analysis is a fundamental part of the financial statements that companies must issue each quarter publicly. The other two analyses would be the cash flow statement and the balance sheet.
By bringing together these three sources of information (profit and loss statement, cash flow, and balance sheet), the maximum insight into the company’s finances is obtained. It is often used in a decisive way for decision-making or modification of business strategies and policies, production, etc.
Usually, they will prepare these profit and loss statements through so-called accounting methods. Also, they will generally use no single period for a complete analysis and decision-making. It is usual to mix different accounting periods as it is over time that the results are meaningful.
How do these reports work?
Although it is part of companies’ three mandatory financial statements, the profit and loss report is probably the best known. It is also the report with the most tools available for its execution. Virtually any basic accounting software will allow its calculation.
An important aspect is that it will not always be presented under the same name. In addition to the Profit and loss statement, it can also appear under the name of:
Income statement and statement of expenses (in separate reports)
- Income statement
- Financial results
- Statement of operations
As with the cash flow statement, the profit and loss statement will show the changes in the company’s accounts over particular periods. It should not be confused with the balance sheet, which is only done at a specific time.
In the case of profit and loss, the information is used for the full length of the period. It is then compared with other similar periods.
Although there are different formats, it is common for the document to start with an income line (top line) and then accumulate expense data. It will release a figure that is known as net income or profit. Depending on the results, this figure may be negative.
Different types of profit and loss status
There is no single way to interpret or perform this analysis. What is important in all cases is to apply comparisons with different periods.
The importance of these comparisons is to determine in which periods revenues and expenses have better or worse relationships. This fact allows for much more effective analyses for business decision-making.
When applying a type of Profit and Loss Statement, we must remember that there is no single form. The two most common are:
This is also known as the cash method of accounting. It is only used when using cash in and out of business. It is the simplest method as it will only account for the money received or paid.
It is the formula most commonly used by small businesses. It is also possible to use it in one’s finances as it is easy to monitor and can be done with any basic accounting software.
This way, we can measure the impact of cash inflows and outflows.
That is a more complex and comprehensive way of obtaining profit and loss data. Using an accrual method accounts for the money that is received and for the money that is expected to be accepted.
For example, companies that ship products and do not collect immediately can include the expectation of collection of those shipments in the accrual method. Also, in the same way, liabilities are to be accounted for even when no expenses are incurred.
It is a formula that allows forecasts to be included in the calculation. Companies with greater accounting control apply it. Its use is considered more effective for companies that already have a track record or maintain a systematic commercial structure.
Differences from other statements and in the balance sheet
The importance of profit and loss statements has already been determined in aspects such as the possibility of making decisions about the company’s business strategies. But there is more to consider.
For example, from an investor’s perspective, we can calculate the return on our investments through this type of analysis. It allows us to make comparisons on net income and thus have a better environment to decide our future actions.
However, we should not confuse the profit and loss analysis with the balance sheet. We will have a snapshot of our financial status on the balance sheet at a given time. Usually, the balance sheet is presented on the last day of the company’s fiscal year.