One of the most important benefits of maintaining an income statement is that it helps a company in calculating its net profit or loss. Income statement is also known as profit and loss account. This is because the difference between total income earned by the company and total expenses incurred by the company will either indicate a profit or a loss for the company.

A company’s profit and loss account is prepared for each year by reporting all incomes on the credit side and all expenses on the debit side of the profit and loss account. In order to calculate the amount of profit or loss, it is important for the accounting department of any organization to ensure accurate and proper recording of all financial transactions in its books of accounts. Proper journal entries are required to be passed along with appropriate entries in different accounting ledgers.

A simple error or omission can result in overstatement or understatement of a company’s profitability or loss position. Since profit and loss account is prepared for an accounting year, it is important to make relevant adjustments for all prepaid and outstanding incomes and expenses in the profit and loss account.

Let Us Discuss Important Steps Involved In Calculation Of Profit And Loss Of A Company

Sales

Total sales made by the company during the year should be credited to the profit and loss account. Total sales includes the amount of cash sales and credit sales made by the company.

Calculate Cost Of Goods Sold

Cost of goods sold is calculated by using the following formula:
Cost of Goods Sold: Opening Stock of Inventory + Purchases + Direct Expenses – Closing Stock of Inventory

Calculate Gross Profit

To calculate gross profit, deduct the value of cost of goods sold from the total value of sales. However, gross profit does not indicate the actual amount of profit earned or loss incurred by the company.

Report Operating Expenses

In order to calculate net profit or loss, all business expenses are required to be reported on the debit side of the profit and loss account. Operating expenses are generally categorized in the form of selling expenses and general and administration expenses.

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Report Non Operating Expenses

In addition to operating expenses, a company is required to report non operating expenses such as income tax, interest etc. on the debit side of the profit and loss account.

Report Non Operating Incomes

Income from other sources such as interest income on short term investments, dividend earned from investment in some other company’s shares is required to be reported on the credit side of the profit and loss account.

Deduct Operating And Non Operating Expenses

Net profit or loss is calculated by deducting the sum of operating and non operating expenses from the sum of gross profit and non operating incomes. If the sum of gross profit and non operating incomes is less than the total value of expenses, company will incur a loss. On the other hand, if the sum of gross profit and non operating incomes is greater than the value of total expenses, company will earn a profit.

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