A Quick Guide Through Profit And Loss Statements

What is a profit and loss (P&L) statement?

Profit and loss statement, also called P&L, statement of operations, or income statement, 

is a financial report which summarizes a company’s revenues, costs, expenses, or profits/losses over a specified period. 

It provides information regarding the company’s abilities, capabilities, or inabilities to manage expenses, generate sales, and more. 

Deeper Definition:

  • The profit & loss statement records how a company generates profits by reducing costs or turning revenues into profits. 
  • This income statement portrays a company’s financial management and investment for a given time, i.e., monthly, quarterly, or annually. 
  • It is one of the most crucial financial statements required to be considered. 
  • It helps in viewing how a company is faring with time.

Salient Points:

  • It is a financial report that summarizes its revenue, cost, and profit incurred over a particular time. 
  • Every public company must issue three-monthly, quarterly, and yearly financial statements: P&L statement, balance sheet, and cash flow statement.
  • P&L statements along with balance sheets and cash flow statements are used together to offer complete information regarding the company’s financial performance.
  • The accrual or cash method of accounting is used to make the statements.

Profit & Loss Statement Structure:

Over a specified time, such as a quarter or fiscal year, the P&L statement of a company is portrayed.

Listed are the main categories found on the P&L:

  • Sales or Revenue
  • Costs
  • Selling, general and administrative expenses (SG&A)
  • Advertising and marketing
  • Research and development
  • Tax
  • Net income etc.

How Profit And Loss Statements Work:

On a quarterly or annual basis, a P&L statement along with other financial statements is issued by the company. It gives information regarding profit and loss generated by a company. Hence, it is the most common and important financial statement in a business plan.

It is also referred to as an earning statement, expense statement, or statement of operation.

As a cash flow statement, a company can see changes in accounts over a certain period of time. On the other hand, the balance sheet shows a snapshot of what a company owns and owes at a particular time. 

Under the accrual method of accounting, a company can log expenses before cash changes hands; therefore, it is necessary to compare profit and loss statements with cash flow statements.

This statement follows a basic form which we showed in the example above. We start with a revenue entry referred to as top-line and subtracts business doing cost including operating expenses, tax expenses, etc. Then the difference is net income, also called the bottom line.

Types Of Profit & Loss Statement:

There are two ways to prepare a P&L statement: the cash method and the accrual method.

1. Cash Method

The cash method is also known as the cash accounting method. When cash comes in and goes out of a company, this method is applied. The cash method is a very simple method that only accounts for receiving or paying cash. 

When cash is received, the company records it as revenue, and when cash is paid, it records it as liabilities. Small businesses or companies mainly prefer this method to manage personal finances.

2. Accrual Method

The accrual method is used to record revenue that is to be earned. The company uses this method to account for money expected to be received shortly. Similarly, a P&L statement records the revenue when a company delivers its services or products to customers even when the payment is due. If the company has not received payment for any expenses, it’s accounted for under liabilities. 

How To Analyze Profit & Loss Statements?

To strengthen a company’s financial performance, the major job is to analyze the profit and loss. 

Here are a few examples of income statement analysis:

  • Analyze the trend matrices whether improving or not
  • Horizontal analysis: compare every year the numbers and benchmarking of a company
  • Looking at gross profit margin, operating margin, net profit margin
  • Rates of return on equity and return on assets

Importance Of Profit and Loss Statements:

The company prepares three financial statements: Profit and Loss statement, balance sheet, and cash flow statement. The P&L statement is majorly used to record companies’ expenses and revenue over time. With this statement and two others, investors calculate return on equity by comparing it with the net income shown on P&L to the level of shareholder’s equity shown on the balance sheet.

Beyond the Profit and Loss Statement:

Analysts also go beyond profit and loss statements to get a full picture of a company’s financial strength. It is also crucial to consider the balance sheet and cash flow statement.

 Analyzing the Balance Sheet:

The balance sheet records the company’s liabilities assets at a time. It is necessary for accessing:

  • Company’s capabilities of generating future revenues
  • Future obligations the company has to meet
  • Working capital
  • To see how a company is structured or financed between debt and equity.

Analyzing the Cash Flow Statement:

This statement shows how much money a company generates and consumes over a certain period. It contains three parts:

  • Cash from operations
  • Cash used in investing
  • Cash from financing

A cash flow statement is important for assessing:

  • How much is a company capable of generating cash from operations
  • Generation of free cash flow
  • How much money is debt and equity
  • Net change over a specified time in cash position
  • The beginning and last period cash balance

References

https://www.investopedia.com/investing/read-corporate-cash-flow-statement/

https://www.investopedia.com/terms/p/plstatement.asp

https://www.thebalance.com/what-is-a-profit-and-loss-statement-5195531

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