What Is A Profit And Loss Statement?
Profit and loss statement, also known as the income statement is a financial report, produced by a company in a quarterly, half-yearly or annual basis, that summarizes company’s revenues, expenses, profits, and losses. The profit and loss statement shows the business-related report of the company and lets investors know, how efficiently the company is running.
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Understanding The Profit And Loss Statement
Profit and loss statements have different names like P&L statement, Income Statement, Statement of Earnings, and Statement of Operations. To Understand the profit and loss statement, you need to understand certain terms like
- Revenue (or Sales)
- Cost of Goods Sold
- Gross Profit
- Operating expenses
- Operating income
- Interest Cost
- Net Income
Revenue is the top line of P&L statements and matters the most. Revenue is the total sales generated by a company. To increase the profitability of a company the first things to improve is sales and it is obvious.
The revenue is the first set of numbers, presented in the profit and loss statement. So most of the analyst focus on the top-line growth of the company.
Cost of Goods Sold
The cost of goods sold also referred to as the cost of sales is the cost of producing products, that are sold or purchased. The cost of sales generally increases, with an increase in revenue and that makes sense, on the other way around it is a red flag for the company.
Cost of goods sold includes all the costs like
- Cost raw materials
- Freight costs
- Storage costs
- Shipping costs
- Labor costs
- Other overhead costs
Gross profit is the difference between the revenue of the company and the cost of goods sold. Gross profit sometimes interchangeably used with gross margins, which is expressed in percentage term.
Gross Profit = Revenue – Cost of goods sold
Operating expanse is the cost to run the business/company/system including rent, salaries, marketing cost, and other bills. Operating expanse excludes the direct costs.
Operating Expanse = Expense – Direct Costs
Operating income, also known as EBITDA (earnings before interest, taxes, depreciation, and amortization) can be calculated by subtracting gross profit by the operating expenses.
Operating Income (EBITDA) = Gross Profit – Operating Expenses
Interest cost is the amount of interest paid by the company on their borrowings over a certain period of time. Most of the business has debts and interest cost is one of the important factors in the balance sheet. An increase in interest costs harms the net income and can make a dent one slow-growing company.
Different countries have different tax slabs, and the company shows the tax they paid in the income statement for the period.
Net Income, also known as the net profit is the bottom line of the P&L statement. Net profit is the final and most important part of the income statement. Net income can be calculated by subtracting the company’s revenue by the cost of goods sold, other expenses, depreciation, interest, amortization, and taxes.
How To Analyse The Profit And Loss Statement
In order to analyze the income statement, you do not need to be a financial analyst just do certain things.
- Compare year over year numbers and quarter over quarter numbers.
- Compare the benchmark of the industry.
- Carefully inspect the gross profit, EBITDA margin, operating margin and the net profit
- Compare the rate of return using tools like return on equity (ROE) and Return on assets.
- Compare important ratios like P/E ratio, Earning per share (EPS), and P/B Ratio.
Why The P&L Statement Is Important?
Profit and loss statement is one of the most important records for a company as well as for its investors. Here are a few importance of P&L statement
- To give investors an idea about the company’s profitability.
- To know the expenses and other costs.
- To know in which department the company is winning and losing.
- To find out the revenue and income sources.
Profit and loss statement or income statement of a company needs to be read carefully and it is necessary to compare it with companies from the same industry using financial ratios and rate of return.