The profit and loss account is a statement that summarises revenues, costs and expenses incurred during a specific period of time – usually quarter or year (investopedia,2011). The purpose of a profit and loss account is to demonstrate if a company has made a profit or a loss over the financial year.
The measurement of profit is key for; managers, bankers and investors, who are usually very interested to see how well a business is doing. The profit signifies the difference between revenues and expenses.
The balance sheet, lists the assets owned by a business, the liabilities owed and the accumulated investments of its owners. These three segments gives investors an idea of how much the company owns and owes (accounting theory and practice, 2001). In comparison to the profit and lose account, the balance sheet provides a financial snapshot at a given moment. It doesn't show day-to-day transactions or the current profitability of the business. However, many of its figures relate to, or are affected by, the state of play with the profit and lose transactions on a given date. There are three ways you may use your balance sheet; to help analyses and improve management within the business, to assist other parties such as investors to measure the value of your business at a specific time and to report annual accounts.
The cash flow statement shows the circulation of money going into or out of a business. It can be presented as a record of something that has happened in the past or more commonly forecasted into the future, signifying what a business expects to spend or receive. Cash flow is vital to a business, as it helps outline how much a company will have to spend at a particular date (investopedia, 2011). Cash flow is usually calculated annually.
The main financial statements listed above, are separated into three different financial statements, because each one has its own role. Each as important as the other. However the balance sheet cannot be a forecast independently of the profit and lose, because of the overlap of a number of elements of the financial statements. Each financial statement becomes stronger and more effective when put together. For example, a business cannot get the cash balance in the balance sheet unless the statement of cash flows and profit and lose have been calculated. This shows that each of the main financial statements is intertwined, but to help understand the importance of each they are separated.
When using budgets in business, the distinction between profit and cash must be clearly understood. Profit and cash are completely different. A business may generate substantial cash receipts, but record only a modest level of profit or even a loss. Alternatively, a business in a strong growth phase may generate significant profits, but not have the cash to pay its bills due to a higher commitment of funds to debtors and stock.
Profit is a financial advantage that is understood when the amount of revenue activity exceeds the expenses, costs and taxes needed to maintain a business (Business dictionary, 2011). Although, profit is gross income less all expenses, the profit may not be present in the form of cash with a company, as some amounts will be due from the customers in the form of bills receivables. This is because statements are usually made on a particular date.
Expenses is an outflow of money for a person or service, for example, a small business would probably have to pay for rent, stock, and even if the profit is currently higher than expenses, it needs to stay fairly high as expenses don’t always leave the company’s bank account when they’re paid.
Each business will have a range of assets. Assets are things of value, which are possessed by a business.