How to Make a Profit and Loss Statement

The first step in the preparation of the profit and loss statement is to ensure that all income in form of sales or other revenues and expenses is properly documented. The records that are used for this purpose are cash receipts to customers, invoices, debit notes, credit notes, bills cash receipts from suppliers, and any other documents that are used to recognize the revenue and expenses transactions. Postings of these source documents goes to the books of original entry that have totals for each category of items.

Accounting Standards

Accounting standards have recommendations for the formats that are to be used in the preparation of the financial statements including the profit and loss statement. Readers are advised to refer to International Financial Reporting Standards (IFRS) and particularly International Financial Reporting Standards 1 - First Adoption of International Financial Reporting Standards and International Accounting Standard 1 - Presentation of Financial Statements. These standards give guidance on how to prepare and present financial statements. In preparing the profit and loss statement, the totals from the ledgers for the particular items are presented line by line.

Books of Original Entry

The books of original entry that consist of sales journal, purchases journal, cash journal and other records compiled out of source documents. The ledgers including the sales ledger, purchases ledger, nominal ledger, and cash books are then generated. It is out of the ledgers that the trial balance is prepared and eventually the statement of profit and loss and statement of financial position.

Profit and Loss Statement

IAS 1 defines profit or loss as "the total of income less expenses, excluding the components of other comprehensive income," and comprehensive income as "items of income and expense (including reclassification adjustments) that are not recognized in profit or loss as required or permitted by other IFRSs."

Presentation of profit and loss statement

The standards recommend a presentation that also shows comparatives for the previous year for purposes of comparison and analytical review. The profit or loss is presented at the bottom of the statement hence the common term "bottom line". The common terms used for income are sales, turnover and revenue. Expenses are classified and grouped according to purpose. Thus we have cost of sales (for businesses dealing with goods for resale), administration expenses, selling and distribution expenses, staff costs, and finance costs. The difference between total income and cost of sales is the gross profit and the difference between gross profit and total expense is either a profit or loss. Where the business reports a profit, it is normally subject to taxation which is deducted before any distribution to owners in form of dividends.

The following is a simple format for the profit and loss statement (on a line by line basis):

Note that there should be two columns on the right one for the current year and the other for the previous year.

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