The profit and loss statement is a critical report when a manager is analysing how well the business is performing.
The statement lists all of the business revenues and the gross profit, which consists of the total revenues less the cost of goods sold.
All other business expenses are then listed and subtracted from the gross profit to give the net profit. Reviewing the profit and loss statement has advantages and disadvantages.
The "bottom line" of the business is one of the best indicators of overall business health.
A business that is showing a profit at the end of the accounting period is doing something right because its expenses are less than the revenue it produces. Without a clearly written profit and loss statement, a manager may surmise that the business is profitable, but she never really knows for sure. Another advantage of a profit and loss statement is that the performance of a business can be compared to other accounting periods to track improvement in the business.
Businesses must create forecasts and budgets based on what the business performance has been in the past. Without an accurate, detailed profit and loss statement, such a forecast would be difficult at best.
The business manager can use the details of the statement over several months to find trends and determine what the future may look like. Any problems can also be spotted quickly and dealt with before they become too serious.
A business manager runs the risk of looking at the profit and loss statement as the only picture of the health of the business. The profit and loss statement is only one item to look at.
The balance sheet is important to show the overall health of the business in terms of the ratio of assets to liabilities, or equity to liabilities. The cash flow statement must also be reviewed to project any potential cash shortages that would not be apparent from the profit and loss statement.
A big disadvantage of the profit and loss statement lies with businesses that report the data too often.
With the widespread use of computerised accounting systems, a profit and loss statement can often be called up and printed on demand. If a manager is looking at the report too often, on a weekly basis or more frequently, it gives an unrealistic picture of the business's financial position because the data sample is too small.