What Is a Profit and Loss Account Used For?

by Sue-Lynn Carty

Profit and loss accounts illustrate whether a company made profits or incurred losses over the year. Profit and loss accounts allow companies to distinguish exactly which areas of their businesses contributed toward profits and which areas caused losses. Accountants summarize the profit and loss accounts on the company's income statement.

Profit and Loss Accounts

In the past, companies referred to their income statement as a profit and loss statement. The profit and loss accounts summarized on the income statement include total revenue, cost of goods sold, operating expenses, operating income and non-recurring income and expenses. The income statement adds up corporate revenues from all sources and subtracts all the expenses, including interest and tax payments, to determine the company's net income. A positive net income means the company earned a profit and a negative net income means it incurred a loss for the reporting period.

Business Purpose

Profit and loss accounts are necessary for departmental budgetary controls. Evaluating these accounts allows a company to determine where it can cut back on expenses for departments that are over budget. It also allows the company to reallocate funds available from departments that are running under budget to other areas within the company. The summary of the profit and loss accounts on the income statement also determines the company's corporate tax rate.

Investor Purposes

Investors look at corporate income statements not only to see if the company is profitable, but also to see how well the company manages its income and controls its expenses. Evaluating a company's profits and losses by analyzing the income statement allows investors to determine the company's profit margin and other financial ratios. Investors will then compare the financial ratios of one company to others within the same industry to determine which company is potentially the most profitable investment.

Considerations

The profit and losses reported on the income statement do not give the full picture of a company's fiscal health because it only reports income and expenses. Other important financial statements used in the financial evaluation of a company include the balance sheet and statement of cash flows. The balance sheet reports the company's assets and liabilities and the statement of cash flows, reports the company's the company's cash in and out flows from operating, investing and financing activities. Using all three financial reports allows investors to see how a company makes, manages and spends its money.

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