Last Updated on Apr 25, 2022 by Aradhana Gotur
The profit and loss (P&L) statement provides invaluable insight into a company’s financial performance. For instance, you can use it to evaluate the revenue growth and profit margin of two different companies in the same industry. Known as comparative company analysis, metrics from such assessments help investors decide which company’s stocks offer better prospects.
Simply put, P&L statement analysis helps the management, investors, and stakeholders understand a company’s financial standing and make informed decisions.
This article sheds light on the fundamentals of what a P&L statement is and how to read and analyse one.
This article covers:
- What is a profit and loss (P&L) statement?
- Example of a P&L statement
- How to read and analyse a profit and loss statement?
What is a profit and loss (P&L) statement?
A P&L statement is a financial statement summarising the costs, expenses, and revenues a company incurs during a specific period. The period typically refers to a quarter or a fiscal year.
P&L statements are prepared in two ways: cash basis or accrual method. The cash basis of accounting considers expenses and revenues only when there’s cash movement. However, the accrual method recognises a company’s revenues and costs even before any cash movement.
Example of a P&L statement
Below is Infosys Limited’s P&L statement for FY 2020 and 2021.
All the figures are in Rs. cr.
|Particulars||FY 2021||FY 2020|
|Cost of sales||65,413||60,732|
|Selling & marketing costs||4,627||4,711|
|Total operating costs||10,437||10,685|
|Other net income||2,201||2,803|
|Profit before taxes||26,628||22,007|
|Net profit attributable to company owners||19,351||16,594|
|Earnings per equity share|
|Weighted average equity shares|
How to read and analyse a profit and loss statement?
Before investing in a company’s stock, it is crucial to analyse its performance over a period of time. The P&L statement is a valuable tool to assess a company’s financial health.
Given below is a list of the typical heads in a P&L statement and how to read them:
Total Sales/Revenue: A company’s revenue is the total amount of sales it makes over a time period, usually a fiscal year. However, it is very important to note that it only indicates the total amount of sales and not the profit. Sales and revenue figures help give an idea about the demand and the market for the company’s products or services, the utilization of the funds by the company’s management and also indicate if the company is progressing or not.
Expenses/Operating costs/ Cost of goods sold: The ‘Expenses’ section enumerates the costs the company incurs in manufacturing, transportation, selling, and other operations. It can help you understand what the company spent to realise the revenue amount. The higher these costs, the lower the profit is likely to be.
Operating profit: Also, referred to as EBIT, it is the profit/income before accounting for interest expense and taxes. In other words, deducting other expenses (like salaries, etc) from revenue gives a company’s operating profit.
Another metric known as the operating profit margin indicates how efficiently a company uses its resources. Dividing the operating profit by the revenue gives the operating profit margin value. The higher the value, the more efficient a company has been in its operations.
Interest expense: The interest expense refers to the interests a company pays on loans from its operating profit. Interest expense will be zero if a company has no debts. However, a higher debt correlates with a higher interest expense. Therefore, interest expense is a vital P&L statement parameter that helps gauge if a company’s debts are persistently increasing.
Depreciation: Depreciation reflects the reduction in the value of a company’s fixed assets over time. Companies have various assets like machines, vehicles, and equipment that lose value over time. The company records such incremental losses through depreciation.
Other incomes: This line item in a P&L statement reflects income not directly related to the company’s business operations. It may include income from miscellaneous sales, interests, dividends, royalties, rents, and the sale of capital assets.
Tax: Every company has to pay tax on its earnings, known as income tax. The tax rate is calculated on the taxable income. The more the company’s tax liability, the more is its cash outgo, and that impacts profits.
A thorough analysis of a company’s P&L statement is pretty vital from an investor’s perspective. Pay attention to the operating profit margin to evaluate the company’s operating efficiency. Likewise, if the interest expense increases, assess where the company uses the borrowed capital and whether it repays debts on time. Since some companies tend to project lower depreciation to inflate profits, look out for that as well.
The P&L statement gives an accurate picture of a company’s performance and whether it has future growth prospects. Moreover, it reveals a company’s business efficiency and whether it has a competitive advantage over its peers. As an investor, you should understand the fundamentals of a P&L statement before using it to analyse a company’s prospects for investing in its stock.