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Profit and Loss Account and Balance Sheet

The profit and loss (P&L) account summarise a business' trading transactions - income, sales, and expenditure - and the resulting profit or loss for a given period. The balance sheet, by comparison, 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 profit and loss transactions on a given date. Any profits that are not paid out as dividends are shown in the retained profit column on the balance sheet.

The amount shown as cash or at the bank under current assets on the balance sheet will be determined in part by the income and expenses recorded in the P&L. For example, if sales income exceeds spending in the period preceding the publication of the accounts, all other things being equal, current assets will be higher than if expenses had outstripped income over the same period.

If the business takes out a short-term loan, this will be shown in the balance sheet under current liabilities, but the loan itself won't appear in the P&L. However, the P&L will include interest payments on that loan in its expenditure column - and these figures will affect the net profitability figure or 'bottom line'.

For preparing a Trading and Profit and Loss Account we need complete information regarding expenses, incomes, assets, and liabilities of the concern. In incomplete records, some details are given and some are missing. Thus, we need to ascertain the missing details in an indirect manner by using the logic of double-entry.

The most common items that are missing and we have to find out for preparing Trading and Profit and Loss Account are:

  • Opening capital

  • Credit Purchases

  • Credit sales

  • Bills payable accepted

  • Bills receivable received

  • Payments to creditor

  • Payments to debtors

  • Any other cash/bank-related items.

As we know that opening capital can be obtained by preparing the statement of affairs at the beginning of the year. For other items that are missing, we can easily obtain them by preparing accounts such as total debtors and total creditors, total bills receivable and total bills payable accounts, and a summary of cash.

The two important parts of the financial statement are the Balance Sheet and the Profit & Loss account. Without the preparation of these two entities the financial statement cannot be reported, even the readers of the statement are not able to clearly understand the company’s position. Hence, due regard is to be given by every company in the preparation of the two. However, people don’t understand them very clearly and have problems distinguishing the two terms.

Balance Sheet

  • Meaning: A statement that shows the company's assets, liabilities, and equity at a specific date

  • Time frame: Financial condition on a certain date

  • Type: Statement

  • Information disclosed: Assets, liabilities, and capital of shareholders

  • The sequence of preparation: It is prepared after the preparation of the Profit & Loss Account

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Profit & Loss Account

  • Meaning: Account that shows the company's revenue and expenses over a period of time

  • Time frame: Financial changes during the period

  • Type: Account

  • Information disclosed: Income, expenses, gains, and losses

  • The sequence of preparation: It is prepared before the preparation of the Balance Sheet

Key Differences between Balance Sheet and Profit & Loss Account

  • The Balance Sheet is prepared at a particular date, usually the end of the financial year while the Profit and Loss account is prepared for a particular period.

  • The Balance Sheet reveals the entity’s financial position, whereas the Profit and Loss account discloses the entity’s financial performance.