A profit and loss statement starts at gross profit, adds other income, deducts every running expense, and ends at net profit. Only costs of running the business during the year go in.
This lesson follows preparing a trading account and sits inside financial statements of a sole trader. The adjustments used below are explained in adjusting accruals and prepayments.
How do you get from gross profit to net profit?
Add income that is not from selling goods, such as commission received. Then deduct all the expenses of running the business during the year, including adjustments. What remains is net profit.
Think of a stall holder. Gross profit is what the goods earned over what they were bought for. Net profit is what is left after paying for the stall, the helper and the electricity as well.
Worked example: Kedai Runcit Hamidah continued
This example continues the trading account from the previous lesson, where gross profit was RM35 700. The year-end notes give:
| Item | RM |
|---|---|
| Commission received | 1 200 |
| Salaries | 14 400 |
| Rent | 6 000 |
| Carriage outwards | 600 |
| Electricity paid | 1 900 |
| Insurance | 1 800 |
| Drawings | 6 000 |
Two adjustments also apply. Electricity of RM200 is owed at year end, and depreciation of RM2 500 is charged on equipment.
Step 1: adjust electricity. Paid RM1 900 plus owing RM200 gives an expense of RM2 100.
Step 2: total the expenses. Salaries 14 400, rent 6 000, carriage outwards 600, electricity 2 100, insurance 1 800 and depreciation 2 500 add up to RM27 400.
Step 3: net profit. Gross profit 35 700 plus commission 1 200 gives RM36 900. Take away expenses of RM27 400 to get RM9 500.
Drawings of RM6 000 stayed out of the statement entirely.
The mistake that lowers net profit
The notes list drawings beside the expenses, and in a hurry it gets included. A longer list of expenses can feel more thorough.
| Line | Wrong | Right |
|---|---|---|
| Expenses total | RM33 400 | RM27 400 |
| Net profit | RM3 500 | RM9 500 |
The owner’s withdrawal is not a running expense of the business. Ask one question of each line: did the business use this up to earn income, or did the owner take it out? Only the first kind is an expense. The debit-credit transaction trainer can help you see why drawings reduce capital instead.
Check yourself
A trader has gross profit RM20 000 and discount received RM300. Expenses are wages RM8 000, rent RM3 600, advertising RM1 200, carriage outwards RM400. Drawings are RM5 000. Find net profit.
Answer
Discount received is other income, so add it: 20 000 + 300 = RM20 300.
Expenses: 8 000 + 3 600 + 1 200 + 400 = RM13 200.
Net profit: 20 300 − 13 200 = RM7 100.
Drawings of RM5 000 is not an expense, so it is ignored here.
What to study next
Net profit now flows into capital. Continue with preparing a statement of financial position, or return to distinguishing gross and net profit if the two profits still blur together.
Practise the whole chapter in the financial statements practice set. If you want a teacher to go through your own exercises, see online one-to-one Accounting tuition.