Trading and Profit and Loss Accounts: Definition, Types, Examples
Businesses need trading and profit & loss accounts to keep track of their total gains. Altogether, these accounts are called final accounts and they provide insights into how efficiently a business is running.
Using the trading and profit & loss accounts, businesses can figure out their assets, liabilities, and total capital. Therefore, every business owner and trader must know about the roles of trading and profit & loss accounts.
So, if you are wondering about what these accounts are, this blog is for you. Keep scrolling to gain insights on trading and profit & loss accounts.
What Is a Trading Account?
In simple terms, trading is the process that involves exchanging, buying, and selling products or services. Trading is the most common practice between two or more parties for financial gains.
A trading account is used by businesses and organisations to compute their gross profits or losses incurred in day-to-day trading activities.
The difference between the cost of goods sold and the net sales helps to calculate a company’s gross profits, which works as an indicator of its business efficiency. While calculating gross profits, you must consider only direct costs and income. The formula to calculate gross profit is given below:
Gross profit = Net selling Price – Total cost of goods sold
To calculate the total cost of goods, you need the following formula:
Total cost of goods sold = Net purchases + Beginning inventory – Ending inventory
A trading account keeps a record of the following items.
- The total purchase price of products after excluding the purchase returns
- All direct costs associated with purchasing, manufacturing, and selling goods
- Total sales of merchandise after excluding returns
- Information about the opening stock of raw materials, semi-finished or finished products
- Details on inventory for raw materials finished and semi-finished goods
What Are the Types of Trading Accounts?
With a trading account, investors can purchase and sell shares instantly. Here are different types of trading accounts, a trader or business owner can use according to their business requirements.
- Equity Trading Account
With an equity trading account, investors can trade with stocks, futures, options, currency, derivatives, etc.
However, an equity trading account alone will not suffice if you are planning to subscribe to an Initial Public Offering (IPO) or hold stocks. An equity trading account is ideal only if you are planning to trade in futures and options as there is no requirement of accepting deliveries here.
- Online and Offline Trading Accounts
As the name suggests, you can access online trading accounts via your mobile and laptop. However, this is not the situation with offline trading accounts. With these accounts, you need to call your broker every time you wish to purchase or sell stocks.
- Commodity Trading Account
A commodity trading account is mandatory for investors who wish to trade and earn from the commodity market.
Although the trading processes are the same in both marketplaces, commodity trading accounts are registered with the commodity exchanges in India. These include National Commodities and Derivative Exchange (NCDEX) and Multi Commodity Exchange (MCX).
- Two-in-one and Three-in-one Accounts
To conduct a successful trade, you need three accounts. These include a savings account for cash transactions, a Demat account for storing securities, and a trading account for buying and selling securities.
Very often, brokerages offer two-in-one accounts that involve Demat and trading accounts. With this, traders do not need to open a Demat account separately. Furthermore, as a marketing move, many traders offer three-in-one accounts. Under this, traders will receive a separate bank savings account to store their gains and pay for securities they purchase.
Example of a Trading Account
Businesses and individuals who frequently buy or sell goods require a trading account. One’s account statement reflects their expenses and income for the sale and purchase of goods or other assets.
For instance, Mr. Freddy purchases securities worth ₹2 lakh and sells them later for ₹4 lakh. In this case, his trading account statement will display ₹2 lakh as an expense for the purchase of securities and ₹4 lakh as his income.
What Is a Profit & Loss Account?
A profit & loss (P/L) account records the profits and losses an individual or business makes or incurs within a period. This account displays the overall profit/loss of a company after adding its revenues and subtracting its expenses.
Businesses and companies keep an accurate P/L account to evaluate their yearly gains and losses. Furthermore, while computing their performances, companies mostly consider all direct and indirect expenses. This includes all cash and non-cash transactions.
What Are the Different Types of Profit & Loss Accounts?
Let’s take a look at the different types of profit & loss accounts.
- Personal Accounts
This account is for individuals and keeps a record of all their transactions including their income and expenses. You can keep track of your expenses and savings using these accounts.
- Nominal Accounts
These accounts help to represent expenses or revenue. Furthermore, companies that do not carry balances in the next financial year maintain the nominal account. So, this account starts with zero balance each year.
- Real Accounts
These accounts are similar to nominal accounts. But the key difference is that these accounts carry forward the final balance to the next fiscal. So, they do not start with zero balance.
Difference between Trading and Profit and Loss Account
Let’s browse through the basic differences between a trading account and a profit & loss account.
|Trading account||Profit & Loss account|
|It records direct expenses and direct revenues.||It also records the indirect expenses of a company or business.|
|We use it to calculate and understand the gross profits or losses of a company’s business.||Helps understand the net profits or losses of a firm.|
|Balance from a trading account is transferred to a profit and loss account.||The balance from a PL account is transferred to a capital account.|
|You can receive a summary of all your direct expenses and direct revenue with a trading account.||Provides a summary of all operating and non-operating expenses.|
|This is independent of any other accounts as the trading account is the primary account.||They are dependent on trading accounts.|
|This account tracks and records receipts and all kinds of payments done with cash and cheque.||Records gains and losses during a particular accounting period.|
|You must create a trading account before creating a profit and loss account.||Consider creating a P/L account after the trading account.|
|You can gain insights on activities to grow your profitability with a trading account.||With this, you can plan steps to improve your overall business.|
|Gross profit % formula = gross profit/ net sales||Net profit formula = gross profit- expense + other income|
Every business owner and trader should consider maintaining trading and profit & loss accounts. By doing so, they gain insights to grow their business with a more economical approach and minimise unnecessary losses.
Maintaining accurate records makes a company transparent for all stakeholders, including owners, employees, and investors. Moreover, it is essential for tax reporting and other legal compliances mandated by the government.
Frequently Asked Question
What is the net income?
Net income is your total earnings after excluding taxes, cost of goods sold, and other expenses.
What is net profit?
This is your actual profit or remaining amount after deducting all kinds of expenses from gross profit.
What are income and expense statements in profit and loss accounts?
Income and expense statements are two important components of P/L accounts. The income statement lists a company’s sales, revenue, and gross profit. On the other hand, expense statements consist of all costs that a company incurred during a given period.
What are the parts of a trading account statement for a business?
The trading account statement records purchases, opening stocks, freight and transportation charges, and purchase returns on its debit side. The credit side includes closing stock, sales, and sales returns.