The profit and loss account statement is more important than the balance sheet which shows the financial position of a business for a specified period. The objectives of profit and loss account point out the progress registered by the company.
The balance sheet does not disclose whether the increase or decrease in surplus as compared with previous years resulted from normal trading or through some unusual income, e.g., fire claim received from an insurance company or, through unusual losses, such as strike or lock-outs.
Objectives of profit and loss account
If the profits are satisfactory in relation to the sale and total capital employed, there is no cause for concern. The object of studying the profit and loss account of a company for a particular year are
- Know trading results: To know the trading results during the period studying profit and loss account is the essential way
- Relate the profits: Relate the profits to following
- The total capital (share capital, reserves, etc., and ling term borrowings) employed in the concern which will indicate its overall profitability;
- The share capital which will indicate the profitability of the share capital employed in the business;
- The relation between profits and turnover: The objective of the profit and loss account is to find out the relation between profits and turnover. It should be seen if, with the increase in sales, the same ratio of profitability has been maintained.
In order to compare trading results for different years, the bank should extract the profit or loss figures for each year separately. For arriving at the figure, and unusual items which do not indicate the legitimate profit relating to the particular period should be excluded.
Just as one should not include any abnormal earnings in the profit figure, he should also exclude unusual losses that have not resulted from the trading of the year, otherwise, the comparison will not be fair and correct.
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