Profit and Loss Account
Category: Financial Risk Management
Next, let us turn to the Profit and Loss Account, which is designed to show the profit or loss which a business achieved or suffered during a particular accounting period. It does this by showing the sales achieved during the period and deducting whatever costs were incurred to achieve those sales.
While a Profit and Loss Account can be for any length of time, we generally look at them for a period of one year.
Different Levels of Profit
In constructing a Profit and Loss Account, expenses are generally grouped into separate categories. As we take away each category of expense from the Sales figure, we get a different level of ‘Profit’. Each level of ‘Profit’ can be analysed to give us a different perspective on the business and how it is operating.
Next shows the outline of how a Profit and Loss Account may be constructed, and the different levels of ‘Profit’.
Gross Profit is the Sales revenue less the direct cost of those sales. In a trading operation, this will effectively represent the ‘mark up’ on the goods sold. In a manufacturing operation, it will represent the margin on production, reflecting the efficiency of the production operation and the appropriateness of the pricing policy.
Operating Profit is a measure of the overall operating efficiency of the business. It is calculated before the interest charge because interest charges are primarily determined by the capital structure of the business and interest rates, neither of which are within the power of anyone on the operating side of the business to influence.
Profit before Tax is a measure of the overall efficiency of the management of the business after taking account of the impact on profitability of the capital structure of the business.
Profit after Tax is the bottom line measure of overall profitability of the business.
Retained Profit shows the amount of additional capital being left in the business to fund future growth.