A profit and loss account keeps track of a business’s annual net worth, which you can calculate by subtracting your liabilities (or money and assets owed) from your net profit. The term “net worth” is often used interchangeably with the term “shareholders’ equity.”
A trading profit and loss account is actually a combination of two accounts in your general ledger, and we’re betting you can guess which two . . . That’s right, the trading account and the profit and loss account.
While a profit and loss account tracks net worth or shareholder equity, a trading account tracks your gross profit—an amount that only relates to sales and purchases of goods or services (that would be the “trading” part of the trading account). To get your gross profit, subtract direct costs from direct revenue.
Combine the two accounts and you get a trading profit and loss account, which shows the outcome of trading activities. The combined account should tell you the profit earned or loss suffered on the purchase and sale of goods.
P&L statements and balance sheets are two of the most important financial statements for a business. A P&L statement overviews how a business is performing by showing revenue, direct costs, and business expenses. In contrast, a balance sheet summarizes all of a business’s long-term assets, liabilities, and shareholders’ equity.
A cash flow statement shows where your cash is coming from and where it’s going. Along with showing money earned from sales, it should show the money you earn from investing and trade opportunities plus cash from bank loans or other financing options. And of course, it details the outflow of cash; like a profit and loss statement, it can tell you if you’re spending more than you’re earning.
Wait, if both statements show your profits and losses, is there really a difference between the two sheets? Yes! A few things set the two apart, but the main one is that an income statement can show non-cash assets and liabilities, not just cash-based ones.
What counts as a non-cash asset and liability? Two of the most common (unfortunately, both liabilities) are depreciation and amortization.
Depreciation refers to an asset losing value over time, like, say, a brand-new commercial washing machine for your laundromat. Before you used it, the machine was worth what you paid for it. But once you run your first load of laundry, the machine experiences normal wear and tear, which lowers its value.
Amortization basically means the same thing as depreciation, but it applies only to intangible assets instead of physical things like washing machines. Those assets could be copyrights for new products or trademarks for new designs, two things companies spend big money on but that start to lose value as soon as they’re purchased.
As you can tell, income statements, balance sheets, and cash flow statements are closely related. Honestly, if you want to see how your business is doing overall, it’s a good idea to work with all three.