The profit and loss account is anxious with measuring the financial performance of a business during a specified period. ‘Financial performance’ during this context refers to at least one question and to at least one question only: ‘Is the business profitable?’
Profit is that the difference between the revenues or sales or turnover (these words have the identical meaning) and therefore the costs incurred in producing those revenues. Revenues represent the invoiced value of the products and services provided to customers. Costs are the expenses involved in generating the revenues.
The practical application of the accounting convention of ‘accruals’ implies that revenues are recognized at the time when the products or services are provided and a sales invoice is raised. it’s not when cash is received from customers. Similarly, costs are included within the profit and loss account in step with the fundamental measure to which they relate and not once they are paid get in cash. Therefore, it’s a significant misconception to think that the profit and loss account may be a summary of the cash coming into and being paid out of a business. As a consequence, earning a profit and generating cash aren’t in any respect the identical thing!
For example, within the year ended 31 March 1998, BAA, the airport operators, earned a profit after taxation (and all other costs) of £277 million.
By contrast, its cash balances actually fell by £209 million, from £306 million to £97 million.
