Differences Between MTM And P&L: What You Need To Know
What is the difference between MTM and P&L? Mark-to-Market is more accurate than Profit & Loss since it is adjusted regularly based on the stock price compared to during transactions only for P&L(e.g. purchase or sales). The market value assists a brokerage (e.g. IBKR) to request a customer to top up their margin account when prices dropped and the portfolio is getting overleveraged.
Not a financial advisor but personally, I don't like P&L as it is not timely and reflects outdated value (e.g. masking paper losses). On the other hand, Mark-to-Market is biased and could be used wrongly (e.g. checking prices daily instead of long term investing).
Below is a table showing a summary of the differences between mark-to-market and profit and loss:-
|Info||Mark-To-Market||Profit & Loss|
|Updated||Regular basis (e.g daily for stock prices, yearly for valuating assets in annual reporting)||Purchases or Sales|
|Usage||Determine market value in assets for better planning||Simple book-keeping or cash accounting|
Require effort to track and update the assets' prices.
Create messy accrual transactions to account for changes
Value can be biased (some blamed Enron on MTM)
Pointless in an inactive market
Not accurate or timely if the environment had changed
Was blamed for the cause of the Orange County Bankruptcy
|Pros||More accurate and timely||Little effort required|
|Sometimes Known As||Market Value, Fair Value||Income and Expense, Income Statement, Financial Statement, Book Value|
Why Mark To Market Is Used Over Profit and Loss
Mark To Market allows
- brokerage to request customers to top up their margin account based on a fair value of the portfolio (especially when prices of stocks dipped). Financial institutions are still required by rules to mark transactions to market prices but more so in a steady market and less so when the market is inactive.
- companies to reflect the rise in their asset prices (e.g. land or building ownership)
- someone to get updated prices of their portfolio and determine whether to reallocate their portfolio accordingly
Case of MTM problem in Enron. For a single contract, Enron signed a 20-year deal with Blockbuster to introduce on-demand video services to various U.S cities by year's end in 2000. After several pilot projects were conducted, Enron claimed an estimated profit of more than $110M from the deal, even if analysts questioned the technical viability of the service. When the network failed to work for the first time, Blockbuster withdrew from its contract. Even though the deal resulted in losses, Enron continued to claim that they were going to make profits.
Why Profit and Loss Used Over Mark-To-Market
Profit and Loss allows
- Investors and companies can hide their paper losses
- Not subject to biased valuation or valuation fees
- easy maintaining as no transactions implies no updates are required
A P&L statement shows the profit and loss of a company over a certain period. It reports on how many sales were made, how much money was spent, what was the cost of goods sold, what was the total expenses, and finally what is the net income or loss for that period.
An MTM statement focuses on cash flow rather than profit or loss for a certain period. It reports on how much cash came in from operations during that time frame and how much cash went out to cover expenses.
Mark to market is an accounting standard governed by the Financial Accounting Standards Board (FASB), which establishes the accounting and financial reporting guidelines for corporations and nonprofit organizations in the United States.
FASB Statement of Interest "SFAS 157–Fair Value Measurements" provides a definition of "fair value" and how to measure it in accordance with generally accepted accounting principles (GAAP). Assets must then be valued for accounting purposes at that fair value and updated on a regular basis
Financial institutions are still required by the rules to mark transactions to market prices but more so in a steady market and less so when the market is inactive. To proponents of the rules, this eliminates the unnecessary "positive feedback loop" that can result in a weakened economy On April 9, 2009, FASB issued an official update to FAS 157 that eases the mark-to-market rules when the market is unsteady or inactive.
In trading, mark to market involves recording the price or value of a security, portfolio, or account to reflect the current market value rather than book value. This is done most often in futures accounts to ensure that margin requirements are being met. If the current market value causes the margin account to fall below its required level, the trader will be faced with a margin call. Mutual funds are also marked to market on a daily basis at the market close so that investors have a better idea of the fund's Net Asset Value (NAV).
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He has been trading since 2008. He started this blog to share the journey about option trading. He dabbled in stocks, bitcoin, ethereum (in Celsius Network), ETF (lazy Dollar Cost Averaging) and also built websites for fun. He used this as a platform to share my experiences and mistakes in trading, especially options which I just picked up.