Need or Purpose and Importance of Profit and Loss Account
There are few purposes of Profit and Loss Accounts with great importance. Although
Calculating the net profit or loss of the company: After completing the trading account, the second step of the financial statement is to prepare profit and loss account. This account bears all types of indirect expenses in the debit side which is balanced with indirect revenues placed under its credit side. The deduction is made from gross profit or loss resulting in net profit or loss.
Calculating the two most important ratios:
The calculation of the net profit ratio depends on the profit and loss account. In order to calculate this amount one has to compare net profit with the company’s net sales. After the end of a certain accounting period, a company compares the net profit ratio with their previous results and fixes all types of imbalance created to achieve better success in future.
This is also a part of profit and loss account. The expenses are compared with sales ratio and then a ratio of expenditure is calculated. This ratio helps in building a better management in future that will keep sales higher than cost needed for production to gain better net profit ratio.
Building a balance between performance and goals: A company must have a dream position as the goal of delivering best business performance. The profit and loss account helps in building a comparison between the actual state and their dream state of business. If there is something lagging behind, a quick step is taken to fix and regain the fast pace.
Preparations for the future: A company can receive better result as well as a bad result when trying different methods to improve their production quality. The preparation for those uncertain outcomes is made through reserves and provision. These are accounts getting their fill from net profit. So if the company doesn’t manage to gain proper net profit, their future may become insecure for any disaster.