Profit and Loss Account in Study of Economics

        It is always the interest of the business to earn profit. This is the underlying reason why business has been motivated to invest and expand on specific production of goods and services. However, the profit of the business is the result of incentive and reward for taking risk to sell a particular product in the market. The high risk business may assume to have high reward or even loss if the business fall short of selling the product.

Generally, the financial profitability is measured by simple illustration that

PROFIT = REVENUE-COSTS

A. Revenue

      The sales of goods and services in the market are usually the revenue or income of the firm. The productivity of the enterprise relies so much on higher revenue in order to meet the financial expenses in the operation of the business.

• Revenue provides financial variables as to the cost of sales and gross profits on a given goods or services produce in the market.

B. Costs

      The production costs of the firm provide financial information as to the expenses on the operation of the business. The costs of the marketing operations must always be lower than the revenue in order to earn profit. It is not only the operation costs (production costs such as administrative, marketing and overhead cost) but also the interest, tax and dividends are included in the costs.

• Operating Cost provides financial variables as to the production cost of sales, marketing and distribution, finance and administration, and other overheads including depreciation. The sum of these variables is the Total Operating Costs.
• Operating Profit is computed by the Gross Profit and deducted by the Operating Costs. While Operating Margin Cost is computed based on the Operating Profit and divide it to the Revenue.
• Other deductions in the operation of a firm include interests, taxes, and dividends in order to get the retained profit                                                                                                                                                   Simple Illustration of the Profit and Loss Accounting

      The task of accounting is to gather relevant data to monitor the financial profitability on the operation of the business. This is done by recording the financial data (Book Keeping) finding out the result through the profit and loss account. For example, a firm has the following financial data:

                                                             P’000                      P’000

Revenue                                                150,000               100,000

Cost of Sales                                           90,000                  55,000

Gross Profit                                             60,000                   45,000

Gross Profit Margin/Revenue                 40 %                       45 %

Operating Costs

Sales, Marketing and Distribution             20,000                   18,000

Financial and Administrative Costs            9,000                     6,000

Other Overhead Production Costs            8,000                     7,000

Depreciation                                              3,500                     3,200

Total Operating Costs                            40,500                     34,200

Operating Profit                                      19,500                     10,800

(Gross Profit less Operating Costs)

Operating Profit Margin                          13.00 %                   10.80 %

( Operating Profit/Revenue)

Interest                                                     (300)                       (250)

Profit Before Tax                                  19,500                       10,550

Taxation                                                   (310)                        (150)

Profit After Tax                                      18,890                       10,400

Dividends                                                5,000                         3,400

RETAINED PROFITS                            13,890                         7,000

      There are 3 parts in the monitoring profit: (1) the trading account; (2) the profit and loss proper ;and (3) the appropriation account.

• The Trading Account. The ‘trading’ means the buying of raw materials to process it for a finished product and selling them to particular market. Likewise, the “money in” is the revenue and “money out” is the costs of the business. (i.e. Gross Profit)
• The Profit and Loss Proper. These are the income received from investment and starts with the Gross Profit. The costs and revenues are added including any other activities not directly related to trading.
• The Appropriation Account. This account presents how profit is appropriated in the profit and loss account.