Two reports tell you almost everything about a business. The profit and loss account tells you whether you made money over a period. The balance sheet tells you what the business owns and owes on a particular date. Banks ask for both, and so does the income-tax return for most businesses that keep accounts.
Step 1: Gross profit (the trading account)
Gross profit is what you earn from buying and selling, before running expenses.
Cost of goods sold = Opening stock + Purchases − Closing stock
Gross profit = Sales − Cost of goods sold
Example for a year:
| Item | Amount |
|---|---|
| Sales | ₹36,00,000 |
| Opening stock | ₹3,00,000 |
| Add: purchases | ₹29,50,000 |
| Less: closing stock | ₹3,80,000 |
| Cost of goods sold | ₹28,70,000 |
| Gross profit | ₹7,30,000 |
Gross margin is ₹7,30,000 ÷ ₹36,00,000, about 20.3%. Use our margin calculator to check margins product by product.
Notice that closing stock matters as much as purchases. If you do not count stock at year end, your profit figure is a guess.
Step 2: Net profit (the profit and loss account)
Subtract every running expense from gross profit.
| Item | Amount |
|---|---|
| Gross profit | ₹7,30,000 |
| Less: shop rent | ₹1,80,000 |
| Less: salaries | ₹1,44,000 |
| Less: electricity and phone | ₹48,000 |
| Less: interest on loan | ₹36,000 |
| Less: depreciation on equipment | ₹20,000 |
| Less: bad debts written off | ₹12,000 |
| Net profit | ₹2,90,000 |
Two items surprise many owners. Depreciation spreads the cost of equipment such as a fridge or a computer over its useful life instead of counting it all in the year you bought it. Bad debts are udhaar you have decided will never be recovered.
What is not an expense: the owner's personal withdrawals (drawings) and the repayment of a loan's principal. Only the interest on the loan is an expense.
Step 3: The balance sheet
A balance sheet lists what the business owns (assets) and what it owes (liabilities and capital) on one date, usually 31 March.
| Liabilities and capital | Amount | Assets | Amount |
|---|---|---|---|
| Capital at start | ₹4,00,000 | Equipment (after depreciation) | ₹1,60,000 |
| Add: net profit | ₹2,90,000 | Closing stock | ₹3,80,000 |
| Less: drawings | ₹1,80,000 | Customers owe (debtors) | ₹1,95,000 |
| Capital at end | ₹5,10,000 | Bank balance | ₹77,000 |
| Bank loan | ₹2,40,000 | Cash in hand | ₹18,000 |
| Suppliers owed (creditors) | ₹80,000 | ||
| Total | ₹8,30,000 | Total | ₹8,30,000 |
The two sides must match. Your khata gives you two of these figures directly: total "you will get" is debtors, and total "you will give" is creditors. The cash book gives you cash in hand.
Three numbers to read from your statements
- Net profit margin: net profit ÷ sales. Here 8.1%.
- Debtor days: debtors ÷ sales × 365. Here about 20 days, which is healthy for most trades.
- Current ratio: (stock + debtors + bank + cash) ÷ (creditors + short-term loans). Above about 1.5 usually means you can pay your bills comfortably.
When you need an accountant
If you are GST-registered, have a loan, or your turnover crosses the tax-audit limits, a qualified accountant should prepare your final accounts. They will also handle adjustments like prepaid expenses, outstanding bills and depreciation rates as per tax law. Our expert desk can connect you with one.
Common questions
Is udhaar given to customers an asset?
Yes. Money customers owe you is an asset called debtors or accounts receivable, as long as you reasonably expect to collect it.
Why is my profit high but my bank balance low?
Profit counts sales when they happen, even on credit. Cash only arrives when customers pay. Stock purchases, loan repayments and drawings also use cash without reducing profit. Read our guide on cash flow versus profit.
This guide is general information to help you understand the topic. It is not legal, tax or financial advice. Rules and rates change; confirm details for your situation with a qualified professional or the official government portal. Read our editorial policy.