Do you run a business? If yes, you would want to grow your investment by making profits. When you buy goods, include the expenses and then sell to make a profit. But how will you know if you are making a profit or not?
You need to keep good records of all your business transactions. When you track your expenses, purchases, returns, and sales, you can gauge the profitability of your business. And trading account records are among the key documents you should have as you run your business.
Are you wondering what is a trading account? Well, it's a document that shows your total sales, purchases, and expenses linked to your purchases and sales. Using a trading account statement, you can quickly determine your business's gross profit.
Trading Account Format
When preparing a trading account statement, you follow a specific format. You will have the debit side and credit side in the trading account. The debit side has information on opening stock value and net purchases (minus purchase returns). You should also have direct expenses on the debit side.
On the credit side, you should indicate the opening stock value (minus the returns) and closing stock value. The difference between values on the credit side and the debit side represents your gross loss or profit. Your business earns a profit if the credit side's value is bigger.
On the other hand, a bigger value on the debit side than the credit side indicates your company didn't make a profit. Check the image below and overview a trading account format.
Explanation of Items on Trading Account
Opening Stock
Your opening stock could be the finished goods you have for selling. Are you in the manufacturing sector? Your opening stock reflects stock of the raw materials, work-in-progress stock and finished goods.
Purchases
Purchases include the goods you've bought for selling. The purchased items reflect the goods you buy on credit and cash with the objective of selling.
Purchase Returns or Return Outwards
You may buy goods from your supplier but return them before selling. Sometimes, those goods could be damaged and can't be sold. That means returning them to your supplier, which reduces your purchases. Therefore, you subtract the goods you produce from your purchases in the trading account.
Sales
The trading account should indicate the value of sales. Your sales include all goods you sell, both on credit or cash. When preparing a trading account statement, you credit sales to the trading account.
Discount on Purchases
When doing business, you can get your goods at a discount. Many suppliers give a discount if you buy in large volumes. You can show discounts on purchases in your trading account. Just deduct a discount value from purchases.
Sales Returns
You may sell goods but find their way back to your store. Maybe, your customer bought the goods but did not satisfy their needs. You will have to deduct returned goods from your sales. Then, you can show the value on your trading account's credit side.
Discounts on Your Sales
Giving your customers a discount on sales encourages them to buy from you. You should factor in a discount on sales in your trading account. That requires you to subtract the discount value from your sales.
Expenses Linked to Purchases and Sales
Doing a business comes with expenses. You will incur direct expenses to convert raw materials into finished goods. Even when you buy finished goods with the objective of selling, you can incur costs. You have to factor in the direct expenses when preparing your trading account.
Some direct expenses you will incur are:
• Wages cost
• Carriage inward and freight cost
• Exercise and custom duty
• Manufacturing expense
Closing Stock
You should consider the value of your closing stock when preparing the trading account. The closing stock is the value of unsold goods in your store. You value the unsold inventory using market or cost price.
Trading, Profit and Loss Account
This is a financial statement that shows you the net profit. The trading account alone shows a gross profit. When you combine the trading account and profit and loss account, your final result will be the net profit. The image below shows an example of trading and profit and loss account format.
Advantages of Trading Account
- A trading account makes it easy for you to determine the gross profit quickly. When you have a trading account statement, you can calculate net sales at a glance. You can compare the current and previous year's net sales to gauge your business success. You only need to look at the present and prior year trading accounts.
- It's easy to compare your opening stock with the closing stock using the trading account statement.
- When a trading account discloses less gross profit than you expected, you can inquire about the cause of the losses. If your gross profit is more than expected, you can take the proper steps to keep the profit high.
- You can use a trading account to determine the ratio of the cost of sold goods and the gross profit. A trading account allows you to compare the gross profit and cost of goods sold. You can easily get data about your stock and the cost of goods sold by looking at your trading account.
- It is easy to gauge the efficiency of your trade activities using a trading account. Looking at a trading account can help you know overstocking/understocking and then make a wise decision.
Trading Account Example
The balance sheet of XYZ ltd., as of 30th May 2021, has the following data –
| Stock as on 1/6/2018 | 10,000 |
| Stock Purchases | 200,000 |
| Freight cost | 15,000 |
| Wage expenses | 50,000 |
| Carriage cost | 10,000 |
| Total sales | 320,000 |
| Sales returns | 10,000 |
| Purchase reruns | 20,000 |
| Stock as of 30th May 2021 | 20,000 |
Using the above data, the trading account of XYZ ltd will appear as indicated below.
XYZ ltd Trading Account as of 30th May 2022
| Dr | Cr | ||
| Particulars | amount | Particulars | Amount |
| Opening stock Purchases a/c 200,00 (less purchase returns 20,000) Freight Wage expenses Carriage cost
Profit/loss a/c | 10,000
180,000 15,000 50,000 10,000
75,000 | Sales a/c 320,000 Less sales returns (10,000)
Closing stock | 310,000
20,000
|
| 330,000 | 330,000 |
Conclusion
Do you intend to invest in stock? You can open a trading account online to buy stocks online. The account will also make it easier to control how your investment grows.
A trading account is essential to monitor the progress of your business. With the best trading account in India, you can compare your business's opening and closing stock by the end of the trading period.
FAQs
Do all businesses have to prepare trading profit and loss accounts?
Businesses should prepare trading profit and loss accounts to help identify the gross and net profit. You will quickly determine the revenue or losses you incur during an accounting period when you develop trade profit and loss accounts.
Do trading profit and loss accounts have another name?
Yes. A trading profit and loss account is also called an income statement.
What steps does a business person follow to calculate profit or loss during a trading period?
- Determine all the revenue made from sales during a trading period, which gives you the total income
- Find all the expenses you have incurred during a trading period. It could be transport, sales expenses, salaries, or the cost of production and storage.
- Take the total income and subtract all the expenses your business has incurred
- When you subtract and find a positive value, your business makes a profit. On the other hand, when you get the difference is negative, it shows you made losses.
What components should one include in the trading profit and loss account?
- Value of sales or revenue
- The cost of sales or cost of your goods
- Expenses incurred from selling, general and administrative expenses
- Interest expenses
- Taxes
- Business net income.
Is there a difference between profit and loss accounts and trading?
Yes. You prepare a trading profit and loss account to ascertain the gross profit for a certain period. A trading account shows the results of trading activities within a trading period. That includes purchases and sales. On the other hand, the profit and loss account represents the actual profit or loss your business earns within an accounting period.