Statement of Profit or Loss and Its Amendments (33.1)
- Thiago Casarin Lucenti
- Dec 9, 2024
- 3 min read
It is important for businesses to keep financial (accounting) records. It helps answers some basic questions about the business operations:
Did the business make a profit/loss?
- It's a measure of performance and an important information for governments, shareholders, managers...
How much do we owe our suppliers?
- If not paid on time suppliers may decline serving the business;
How much are owed by customers?
- Carefully tracking trade receivables to avoid cash-flow problems;
Can we repay bank loans?
- Or else raising finance will be difficult;
Have our expenses (including salaries) been paid?
- Company vs. workers relations;
Are we able to pay dividends?
- Shareholders may reconsider their investments.
Keeping financial records does not need to be difficult - specially since there are many financial statements to help businesses doing so - we will focus on two:
Starting from the Statement of Profit or Loss (former Income Statement) also referred as the Profit or Loss Account:
It records revenues, costs, profits, and losses over time. The Income Statement is made out of three main sections:
Let's discuss each section individually:
Trading Account: records revenues and cost of sales equaling gross profits:
- Revenue = Price * Quantity Sold
- Revenue # Profit
- COS = (Opening Inventories + Purchased or Manufactured Goods) - Closing Inventories
Opening Inventories (start of the year) = $500
Purchases or Manufactured (during the year) = $2500
Total Inventories available (for sale) = $3000
Closing Inventories (end of the year) = $750
- COS = (500 + 2500) - 750
- COS = $2250
- Gross Profit = Revenue - COS
Activity 33.1 (Q1)
Profit & Loss: calculation of the operating profits before taxes as well as the profit for the year, which then includes taxes:
- Overhead expenses are those not directly related to the number of items made/sold (e.g. rent, management salaries, marketing promotion, depreciation).
Appropriation Account: shows the split of the profit of the year between dividends and retained profits:
Having a positive Profit of the Year (after taxes) is not always a sign of a healthy business. Any guesses on why?
Beware of Low-Quality Profits:
Profit that comes from the production and commercialization of products/services is considered to be a high-quality profit as it is sustainable over time.
On the other hand, non-operating revenues and profits which can happen from activities such as the sale of non-current assets is considered to be low-quality profit as it's not sustainable over time.
Income Statement Uses:
- Measure and compare performance overtime (year-on-year);
- Compare performance with other businesses in the industry;
- Actual vs. Expected profits can be compared;
- Investors use the income statement for aiding their decision-making;
- A look over revenues vs. cost of sales.
Businesses produce a more detailed version of the income statement with a breakdown of revenues and costs for internal use on a monthly basis;
A more generic version is produced yearly for external stakeholders' purposes.
Activity 33.2 (Q1)
Managers preparing such financial statements will oftentimes find the need for doing amendments: revisions / changes as new information becomes available. When performing amendments, keep in mind the following:
The same format of the statement should be kept;
Changes in number of units sold/produced will likely change revenue and COS values;
Some overhead expenses (e.g. transportation, promotion) might also change with variation in sales units.
Activity 33.3 (Q1 and Q2)
Q3 Discussion:
Here are some automatic impacts that will the Statement of Profit or Loss will suffer from changes:
Chapter 33 - Financial Statements
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