state the purposes of measuring business profit and loss

1.1 The Purpose of Accounting

Objective

State the purposes of measuring business profit and loss.

Book‑keeping vs Accounting

• Book‑keeping – systematic recording of every financial transaction (sales, purchases, receipts, payments) in journals and ledgers.
• Accounting – interpretation, analysis and communication of the recorded information to produce reports (profit & loss account, balance sheet, cash‑flow statement) that help both internal and external users monitor performance and make decisions.

Why Measure Profit & Loss?

Profit is the surplus after all expenses are deducted from revenue; a loss occurs when expenses exceed revenue. Measuring profit or loss provides information that enables a business to:

• Monitor progress over time (trend analysis of profit figures).
• Evaluate performance against targets, benchmarks and industry standards.
• Make informed decisions about pricing, product mix, expansion, investment or cost‑cutting.
• Provide reliable information to external users – shareholders, lenders, investors and tax authorities.
• Calculate the amount of tax payable and satisfy legal reporting requirements.
• Identify areas where costs are too high or revenue is insufficient and take corrective action.

Role of Accounting in Monitoring Progress & Decision‑Making

Beyond the profit‑and‑loss figure, accounting supplies a range of information – asset values, liabilities, cash‑flow data and financial ratios – that managers use to:

• Track the business’s financial health month‑by‑month or year‑by‑year.
• Plan future actions, set realistic budgets and forecast cash flows.
• Ensure the business stays on a sustainable financial path.

The Accounting Equation and Its Link to Profit‑Loss

Owner’s equity changes when the business makes a profit (equity increases) or incurs a loss (equity decreases). Thus, the profit‑and‑loss account directly influences the right‑hand side of the equation.

Worked Example – Linking Net Profit to Owner’s Equity

Key Purposes of Measuring Profit & Loss

• Performance evaluation – shows how efficiently resources have been used to generate earnings.
  Example: A higher gross‑profit margin indicates good control of production costs.
• Decision‑making – supplies data for strategic choices such as pricing, product mix and investment.
  Example: If net profit falls, management may review variable costs.
• Financial planning – helps forecast future cash flows and set realistic budgets.
  Example: Expected profit trends are used to prepare the cash‑flow forecast for the next year.
• External reporting – provides shareholders, lenders and tax authorities with reliable information.
  Example: Annual accounts submitted to Companies House must include a profit‑and‑loss statement.
• Control & accountability – enables managers to monitor cost control and hold departments accountable.
  Example: Departmental profit centres are compared against budgeted figures.

Typical Profit & Loss Statement Layout (Simplified)

All figures are in dollars for one accounting period.

Analysis Prompt

Based on the above profit‑and‑loss statement, answer the following:

• What does the gross‑profit margin (Gross Profit ÷ Sales Revenue) tell you about the business’s production efficiency?
• If the owner wishes to increase the profit for the year by $1 000 without changing sales, which expense category would be the most effective to target and why?

Summary

Measuring profit and loss is a core function of accounting. It provides essential information for:

• Monitoring business progress over time (trend analysis).
• Evaluating performance against targets and industry benchmarks.
• Supporting strategic decision‑making.
• Fulfilling legal and tax compliance requirements.
• Providing external users – shareholders, lenders and tax authorities – with reliable data.
• Controlling costs and holding managers accountable.

The profit‑and‑loss figure directly affects the owner’s equity component of the accounting equation, linking the income statement to the balance sheet and completing the picture of a business’s financial health.