A profit and loss statement, also known as a traditional income statement, demonstrates if a company is profitable or not during a certain period of time. A traditional income statement provides summary information on how the company obtains its income and incurs expenses in the framework of operating and non-operating activities.
Explanation:
A traditional income statement is undoubtedly one of the most essential primary financial statements of the firm. It represents the results of the organization’s operations during any period. Also, the traditional income statement is one of the most crucial means of financial reporting. It shows whether or not a company has successfully made money during the reported period.
The profit and loss statement considers an enterprise’s transactions during a certain period of time, taking into account all expenses and income received during this period, and breaks down the data until only the net income is left. It provides information on risk, financial flexibility, return on investment, and operational opportunities related to the business.
Along with the traditional method, some companies also use a cost volume profit statement and a contribution margin income statement. The company’s variable costs in the contribution margin income statement are subtracted from sales in order to obtain a contribution margin.
Marginal profit is the company’s revenue without its variable costs, and it demonstrates how much of the company’s income contributes to its fixed costs and net costs. After determining the contribution margin, the company can deduct all applicable fixed expenses in order to obtain a net profit or loss for the needed period.
The traditional income statement works by separating the costs of that arise during the production of an item from the expenses that are incurred during the sale of that product. In contrast, in the contribution margin statement, variable costs are separated from fixed costs.
Traditional reports and profit and loss statements show in detail the firm’s finances for a reported period of time. Although both serve to show if an organization has net profit or loss, they differ in how they reach this figure. The difference between a traditional income statement and a cost volume profit income statement is that the latter is used to analyze how changes in costs and volume affect an organization’s operating and net incomes.
There are some pros and cons of the traditional income statement. The first advantage is that it provides detailed information on revenues. Besides the usual costs, it also accounts for additional costs like taxes. Moreover, this statement accounts for incomes obtained from sales and factors in earnings gained from non-operational components.
The second advantage is that the traditional income statement is a useful tool for investor analysis. Before putting money into an organization, investors need to review an important document with detailed information about the company’s sales, and profits, operational efficiency, and other non-operational aspects.
However, there are a few disadvantages of the traditional income statement. The first is the misrepresentation of data. For example, the data in the statement not only includes current incomes from sales but also the expenses that the business has not paid yet. The second disadvantage is that the traditional income statement cannot help predict future growth.
It has data regarding the earnings per share and some other past financial information, but it does not provide any indication of how the income generation happens. Thus, a company may underpay its employees and overcharge the clients to earn more money and gain its profits.