The Main Parts of Profit and Loss Account (P&L Account)

Profit and Loss Account (P&L Account), or an income statement, contains financial data which business stakeholder groups find extremely useful. It shows the Sales Revenue, all business costs and profit or loss of a business over a given period of time. It is one of the Final Accounts.

Profit and Loss Account (P&L Account) is produced both for internal use and external use. Internally, managers need timely access to as much financial information as possible to make important business decisions. Externally, current shareholders and potential new investors need information to assess the performance of their investment, or make decisions whether to invest in this company or not.

Commonly, there are three sections each Profit and Loss Account (P&L Account) has. Each of those sections gives a different profit figure: 

1. Trading Account
2. Profit and Loss Account
3. Appropriation Account

The content of Profit and Loss Account (P&L Account) is laid down by specific regulatory bodies in each country. But it can be easily assumed that there will not be much differences between Profit and Loss Account (P&L Account) regardless of the country where the business operates.

1. Trading Account

Trading account is the first section of Profit and Loss Account (P&L Account). It shows how much Sales Revenue the business made, what the cost of production was and how much Gross Profit, or loss, has been made from normal trading activities. Specifically, it shows the difference between a firm’s Sales Revenue and its costs of producing or purchasing products to sell.

Sales Revenue

Sales Revenue is the value of products sold to customers. It is calculated as follows:

Sales Revenue = Price x Quantity

Example: Calculating Sales Revenue 

In 2021, the hamburger restaurants sold 1,000 burgers at USD3 x 1,000
Sales Revenue = USD3,000 in Sales Revenue. 

Cost of Goods Sold (COGS)

This position in Profit and Loss Account (P&L Account) can very simply be referred to as the cost production – Direct Costs or Variable Costs (VC). The cost of producing all those goods and/or services that were sold to customers during the financial year. 

In a manufacturing company, Cost of Goods Sold (COGS) is the cost of goods manufactured (e.g. raw materials, wages for production workers, packaging, etc.) plus the beginning finished goods inventory minus the ending finished goods inventory. In a retail business, Cost of Goods Sold (COGS) is the beginning inventory plus the cost of buying goods from the manufacturer minus ending inventory. In a service business, Cost of Goods Sold (COGS) is the cost of the employee services rendered. 

Cost of Goods Sold (COGS) = Opening Stock + Purchases – Closing Stock

Only the goods used and sold during the year will be recorded in Cost of Goods Sold (COGS), or cost of sales. 

Example: Calculating Cost of Goods Sold (COGS) 

If the hamburger restaurant opens trading on January 1, 2021 with USD3,000, then the business has costs of stock valued at 2,000 worth of stock remaining.

Question: Using the formula, how much was Cost of Goods Sold (COGS)?

Cost of Goods Sold (COGS) = Opening Stock + Purchases – Closing Stock
COGS = USD3,000 - USD2,000 

Answer: The Cost of Goods Sold (COGS) is USD2,000.

The above Cost of Goods Sold (COGS) can be further broken down into more details:

SALES REVENUE		1,000
+
Purchases (during the year)		4,000
–
Closing Stock (at the end of the year)		2,000

Gross Profit

The very end of the trading account shows Gross Profit. Gross Profit is calculated by subtracting Direct Costs, or Variable Costs (VC) of trading from Sales Revenue:

Gross Profit = Sales Revenue – Cost of Goods Sold (COGS)

So, Gross Profit is the difference between Sales Revenue earned from selling products and the cost of making those products.

Example: Calculating Gross Profit

In 2021, the hamburger restaurants generated USD2,000. 

Question: How much Gross Profit did this restaurant earn?

Gross Profit = Sales Revenue - Cost of Goods Sold (COGS)
Gross Profit = USD2,000
Gross Profit = USD1,000 Gross Profit in 2021.

Let’s take a look what Trading Account would look like now: 

SALES REVENUE		2,000
GROSS PROFIT		1,000 Gross Profit in 2021. The restaurant also has to cover expenses of USD1,000 – USD600Answer: The hamburger restaurant generated Net Profit Before Interest and TAX of USD1,000 2021. The h restaurant also needs to pay monthly Interest if USD600 – USD100 Net Profit After Interest and TAX = USD400 in 2021. Let’s take a look what Profit and Loss Account would look like now:  GROSS PROFIT 400 NET PROFIT BEFORE INTEREST AND TAX 100 TAX (20%) 400 3. Appropriation Account Appropriation Account is the third and final section of Profit and Loss Account (P&L Account). It shows how Net Profit After Interest and TAX, or the profit for the year, is distributed between the owners. This is done in the form of paying out dividends to company shareholders. Any remaining amount will be kept in the business as retained earnings for future business growth to fund new projects. Dividends Dividend is a part of the Net Profit After Interest and TAX paid to the owners of the company (shareholders) as a return for investing in the company. Dividends are allocated based on the decision of The Board of Directors which must be approved at the company’s Annual General Meeting. Most of the companies which pay dividends pay them quarterly, while some pay biannually and some even pay monthly such as many Real Estate Investment Trusts (REITs).  NOTE! The figures about Dividends are transferred to Balance Sheet and shown under the section Current Liabilities. Retained Profit Retained earnings is the amount of profit left after all costs, Interest, TAXes and dividends have been paid out from Sales Revenue. Retained Profit is ‘ploughed back’ into the company as an internal source of finance. The business will use it for internal purposes such as expanding the business. NOTE! The figures about Retained Profit are transferred to Balance Sheet and shown under the section Shareholder’s Equity. The owners of any profitable business usually decide to reinvest some of the profits back into the firm instead of paying out everything to themselves. Example: Calculating Retained Profit The hamburger restaurant generated Net Profit After Interest and TAX of USD400 that the company earned in 2021. He will keep USD300 as Retained Profit to reinvest back into the business. He is planning to buy a pizza oven next year to also sell pizzas as some of his customers want to buy both hamburgers and pizzas. Let’s take a look what appropriation account would look like now:  NET PROFIT AFTER INTEREST AND TAX 100 Retained Profit (75%) 3,000 Cost of Goods Sold (COGS) 1,000 Expenses (Overheads) 600 Interest 100 NET PROFIT AFTER INTEREST AND TAX 100 Retained Profit (75%) $300 Therefore, in reality, combining the three parts of the account will produce the final Profit and Loss Account (P&L Account). Jerry Grzegorzek I am the Founder and Editor-in-Chief of the SuperBusinessManager.com website. I am the EU citizen with approximately 20 years of experience in secondary and higher business education in both public and private sectors. Currently living with my wife and our two adorable children in China where I teach Business Management and Economics at K-12 international schools. Professionally, I am an experienced Lecturer and Researcher in Business Management and Economics, as well as IB Examiner for DP Business Management at International Baccalaureate (IB). Privately, I enjoy reading and collecting books on business management, personal finance and investing. You can contact me at jerrygrzegorzek@hotmail.com « The Importance of Balance Sheet    |    How to Improve Gross Profit? » Comments are closed. Scroll to the top