Commercial gain or profit is the most critical component for anyone engaging in business. This is one of the most crucial factors determining the economic viability of any business.
Businesses need to understand how much income or revenue they generate and the profit earned. Various methods or accounts can be adopted to analyze this information.
Two of the most crucial income and profitability statements are Trading Account and Profit and Loss Account.
Key Takeaways
- A trading account is a financial statement summarizing the revenue and expenses of buying and selling goods. In contrast, a profit and loss account is a financial statement that summarizes all revenue and expenses, including non-operating items.
- The trading account calculates a business’s gross profit or loss, while the profit and loss account calculates the net profit or loss.
- A trading account is primarily used by businesses engaged in trading activities, while a profit and loss account applies to all types of businesses.
Trading Account vs Profit and Loss Account
A Trading account is a financial statement that shows the gross profit or loss of a business over a specified period. A Profit and Loss account, also known as an Income statement, is a financial statement that summarizes a company’s revenues, expenses, and net profit or loss over a specified period.
However, the above is not the only difference. A comparison between both the terms on specific parameters can shed light on subtle aspects:
Comparison Table
| Parameter of Comparison | Trading Account | Profit and Loss Account |
|---|---|---|
| Meaning | Account showing the gross profit or gross loss from business activities | Statement showing the net profit earned or net loss sustained from business |
| Purpose | Summarize the overall result of the business activities in monetary terms | Summarize specific profit generated or loss sustained |
| Stage of accounts preparation | First stage | Second stage |
| Which is prepared first | Trading Account is ready before the Profit and Loss Account | The profit and Loss Account is designed after the preparation of the Trading Account |
| Type of profit summarized | Gross Profit | Net profit |
| Dependency on the trial balance | No | The profit and loss account depends on the Trading Account’s figures. |
| Utility | Trading Account is less valid because it does not consider indirect income or expenses. | A profit and Loss Account is more beneficial as it denotes the net profit or loss. |
| Treatment in the balance sheet | No | Yes, the balance is added or subtracted from the capital account |
What is Trading Account?
Trading Account is a type of income or financial statement. Ideally, this is the first income statement any business prepares to ascertain the business operations results.
A trading account is the first statement in which a business can understand its financial position.
A trading Account indicates gross profit or loss, which is based on a formula whereby the cost of goods sold is subtracted from net sales to arrive at the final figure. Gross profit only will include direct income and direct expenses.
So, in formula terms,
Gross Profit or Gross Loss = Net Sale less Cost of Goods Sold
Trading Account indicates the profit earned or loss sustained from trading operations. Trading Account will not take into consideration any indirect incomes or indirect expenses.
The depicted gross profit or loss can be considered the awful result of trading activities.
Trading Account contains two sides: a debit side or a column denoting direct expenses. The other side, viz., the credit side, is for signifying immediate income.
For a business, direct expenses can be considered the cost incurred to manufacture goods. Such costs may include raw materials, power, freight, etc.
The income will denote the money received from selling the goods/services.
What is Profit and Loss Account?
A profit and Loss Account is an essential financial statement for any business. Profit and Loss Statement is considered critical for any business that needs to understand if they are indeed operating at a net profit or a net loss which data may not be available from preliminary financial statements.
The profit and Loss Account is also known as Income Statement.
The profit and Loss Account indicates the net profit earned or the net loss sustained by the business selling the goods or providing the services. A profit and Loss Account can provide the net figure of either a profit or loss because it considers specific other monetary components such as operating and non-operating expenses and revenues.
The profit and Loss Account indicates either net profit or net loss, which is calculated by considering any indirect income or expenses. Therefore, in formula terms,
Net Profit or Net loss= (Gross Profit or Gross Loss) + (Indirect Income – Indirect Expenses), where
Indirect incomes denote the income generated from activities other than the primary activities of a business, and indirect expenses signify all expenses other than direct business expenses.
The profit and Loss Account is ideally developed once the Trading Account is finalised. This is so because the balance from the Trading Account needs to be transferred to the Profit and Loss Account to determine the net profit/loss.
A profit and Loss Account has two sides, viz., a debit side and a credit side. The debit side is for indicating expenses, and the credit side is for denoting incomes.
The profit and Loss Account will show a net profit when the credit side amount is more than the debit side and a net loss when the debit side is more than the credit side.
The balance from the Profit and Loss Account (irrespective of whether it is a net profit or net loss) is finally transferred to the balance sheet (under the capital account).
Main Differences Between Trading Accounts and Profit and Loss Accounts
- Trading Account shows the overall monetary results of the business. The profit and Loss Account shows specific financial consequences of trade.
- Trading Account provides information on gross profit or gross loss. A profit and Loss Account is helpful in ascertaining net profit or a net loss.
- Trading Account provides information on direct expenses and direct revenues. The profit and Loss Account provides insight into indirect costs and income figures.
- Trading Account is prepared before the finalization of the Profit and Loss Account. The profit and Loss Account is prepared after the finalization of the Trading Account.
- The Trading Account balance is transferred to the Profit and Loss Account. The profit and Loss Account balance is transferred to the capital account in the Balance Sheet.
- Trading Account is not dependent on figures from the trial balance. The profit and Loss Account depends on the trading account’s gross profit/loss figures.
- https://content.sciendo.com/view/journals/kbo/23/2/article-p36.xml
- http://ns1.upet.ro/annals/economics/pdf/2011/part4/Rascolean-Isac-Szabo.pdf
Last Updated : 11 June, 2023
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
The detailed comparison between trading and profit and loss account is highly informative and enlightening. It effectively highlights the critical differences between the two statements, providing invaluable knowledge for businesses.
I completely agree. This comparison is essential for businesses to accurately analyze their financial performance and make informed decisions based on their financial statements.
The detailed explanation of the purpose and significance of the trading and profit and loss accounts is enlightening. Understanding the preparatory stages of these accounts is essential for any business owner or accountant.
Indeed. The post provides a comprehensive insight into the first and second stages of account preparation, which is highly beneficial for businesses to understand their financial status.
The post effectively outlines the utility and benefit of the profit and loss account over the trading account due to its consideration of indirect income or expenses. This information is invaluable for informed financial decision-making.
Absolutely, the importance of considering indirect income and expenses in the profit and loss account cannot be overstated. This insight is crucial for businesses to navigate their financial standing.
Thank you for providing such detailed information. As you stated, profit and loss account is critical for a business to understand if they are operating at a net profit or a net loss. Businesses must analyze these statements in order to succeed.
Yes, this is very useful data. Businesses need to understand these terms in order to make the best financial decisions.
This is important indeed. Analyzing the trading account and profit and loss account can help determine the economic viability of any business.
This is a very informative and comprehensive article on trading and profit and loss accounts. The clear explanations are highly valuable for any reader looking to enhance their understanding of these financial statements.
I appreciate the clear explanation of the differences between trading account and profit and loss account. However, I question if the trading account is less valid because it does not consider indirect income or expenses.
I understand your concern. It’s true that the profit and loss account is more beneficial as it denotes the net profit or loss, but the trading account is not less valid as it serves the purpose of summarizing the overall result of the business activities.
I appreciate the formula explanation for both trading and profit and loss accounts. It’s essential to understand the calculation of gross and net profit or loss, and this post provides a clear breakdown of these calculations.
Definitely. The formulas provided increase the clarity and understanding of how gross and net profit or loss are calculated. This is vital knowledge for businesses.
Trading account is indeed the first income statement any business prepares to ascertain the business operations results. This post provides a comprehensive understanding of the importance and purpose of trading and profit and loss accounts.
Absolutely, the detailed explanation of both accounts is incredibly insightful for business owners and stakeholders. Understanding these financial statements is crucial for financial decision-making.
I couldn’t agree more. The discussion on the treatment in the balance sheet and the dependency on the trial balance adds depth to the understanding of these financial statements.
I find the Comparison Table very helpful in understanding the differences between trading account and profit and loss account. This provides a clear breakdown of specific parameters which shed light on subtle aspects.
The detailed comparison table serves as a valuable tool for businesses to analyze and understand their financial position based on trading and profit and loss activities.
Absolutely, the Comparison Table makes it easier to comprehend the distinction between the two statements. The parameters of comparison are well-explained.
The informative yet detailed format of this post makes it an invaluable resource for individuals seeking to gain insights into the intricacies of trading and profit and loss accounts.
Indeed, the post is an excellent guide for understanding trading and profit and loss accounts, providing an in-depth analysis that is highly beneficial for businesses and financial professionals.
Absolutely. The post effectively breaks down the intricate details, making it accessible and comprehensive for readers to grasp the nuances of these financial statements.