Profit and Loss Statement

A profit and loss statement (P&L) shows your business's earnings, expenses, and profit or loss over time.
Profit and Loss Statement
3 min
03-July-2024

When planning to invest in the stocks of any company, one has to do thorough research about the functioning, performance, and prospects of that company and its stocks. For this purpose, a lot of information is available to the investor, which needs to be understood and analysed to make an informed decision.

A profit and loss statement is a document that lets investors know about the profits earned or losses incurred by a business during a particular period. It is mandatory by law for companies to release this statement.

In this article, we will dive into the fundamental aspects of a P&L statement, providing a clear definition and exploring its significance in assessing a company's financial health. We will present an example of a P&L statement, breaking down its key components, and offer a step-by-step guide on how to read and interpret the figures. Additionally, we will discuss how to use this information to make informed business decisions and highlight common pitfalls to avoid. By the end of this article, you will have a comprehensive understanding of P&L statements and their role in financial management.

What is a profit and loss statement?

A profit and loss statement is a financial statement released by a company that gives information about its performance during a particular time frame. It is also referred to as the P&L statement, earning statement, or income statement.

The P&L statement provides information about the company’s revenue during a particular period, including the expenses, tax and depreciation, and the earnings per share. Essentially, it is a summary of revenue, expenses, profit, or loss made by a company during a particular time frame, which can be monthly, quarterly, biannual, or annual.

The profit and loss statement is one of the three essential information documents released by companies that assist investors in making informed investment decisions. It is mandatory under the Company Law for the businesses to prepare and release this statement.

Example of a P&L statement

Now that you know the P&L statement’s meaning, here is an example to elaborate and further clarify the concept of the profit and loss statement. Let us consider a hypothetical company, ‘XYZ Limited’, which is a toy manufacturing company. During the month of April 2024, XYZ Limited made a total sale of Rs. 10 lakh while the cost of raw materials was Rs. 5 lakh. The salary of the staff was around Rs. 2 lakh and electricity charges stood at Rs. 50,000.

The profit and loss statement of XYZ Limited will, therefore, be:

Item

Amount (Rs.)

Total Sales

10,00,000

Cost of Raw Materials

(5,00,000)

Salary Expenses

(2,00,000)

Electricity Charges

(50,000)

Total Expenses

(7,50,000)

Operating Income (EBIT)

2,50,000


Also read:
How does total expense ratio (TER) work?

How to read a P&L statement?

A company’s profit and loss statement contains information on the business’s revenues compared to its expenses and profits and losses in a given period. If you want to read a profit and loss statement, it would include the following sections:

  • Total revenue
    It is the income that an organisation earns from its primary products or services. This income may be divided into categories for different products or services.
  • Gross profit
    Gross profit is calculated by subtracting the cost of goods sold (COGS) from the total revenue. It is important to note that the cost of goods sold is inclusive of the expenses incurred when selling the company’s goods or services. For instance, the COGS includes transportation, packaging, and raw material costs, which are later deducted from the total revenue.
  • Operating expenses
    The operating expenses for a company include all the expenditures that are incurred on the primary goods or services but are not directly related to their sale. These expenses include marketing or insurance costs, rent, utilities, etc.
  • Net profit or loss
    This refers to the amount of profit or loss that a business is left with after the total expenses are deducted from its gross profits. This is also known as the bottom line.

The P&L statement, along with the cash flow statement and balance sheet, provides a detailed picture of a company's financial health. It shows the company's operating performance and the expenses and costs that affect its profit margin. By reading and assessing a P&L statement, you can gain insights into a company's potential to improve sales growth, generate revenue, optimise its operating structure by reducing costs, and increase profitability by achieving higher margins.

If you are reading a company's profit and loss statement, keep in mind that a business may use synonymous terms for these sections, such as net sales, net revenue, gross revenue, and gross margin. Also, when public companies issue a P&L statement, they often include more information, such as operating income, interests, and taxes, among others.

Also read: How to evaluate mutual fund performance?

Types of P&L statements

There are two basic types of P&L statements, differentiated from each other on the basis of accounting methods used in calculations. The two types are the cash method and accrual method.

Cash method

It is also called the cash accounting method. This method is when the company’s transactions are only done in cash. It is, therefore, based on simple calculations of cash received and paid. In this case, the cash received is referred to as revenue, while the cash paid is referred to as expenditure. The cash method is mainly used by small-sized companies.

Accrual method

This accounting method is not based on cash transactions; rather, it refers to the accounting mechanism based on revenues and expenses that have been earned and incurred but not yet paid for. This method is used by large companies that do not work on the basis of immediate cash transactions.

How do you compare P&L statements?

It is important to understand how to compare different P&L statements, as they provide a strong reference to the company's performance, growth, and prospects. Here are the key points that can help you compare P&L statements:

  • Time Frame: You must compare the profit and loss statements from similar time frames, e.g., the March 2024 statement with the March 2023 statement or the particular festival month statement of the past year with the same festival month of this year. This will help you establish meaningful trends.
  • Significant changes: When you compare different P&L statements, you must look for drastic and significant changes in revenue, expenditures, profits, or loss. Once you locate the change, you can investigate the reason behind it and consider it in your decision-making process.

Also read: Differences between debt and equity mutual funds

How to prepare the profit and loss statement (P&L)?

To prepare a profit and loss statement, the first step is to prepare the ledger accounts from the journal so that the closing balance can be determined. Then, a trial balance is created that contains a summary of all the ledger accounts. It lists each ledger account with its corresponding closing balance. Finally, the trading, profit and loss statements are crafted by posting all ledger accounts related to purchases, sales, direct and indirect expenses, and income.

To prepare the profit and loss statement, an organisation relies on one of the following methodologies:

Accrual accounting

Under this method, companies note income and expenses, which are reported based on the actual dates of transactions instead of when payments are realised for the same. This includes both payments that are received and made. Under this method of accounting, a company notes when a product has been delivered and not when the payment for it is received. On the flip side, the business notes when they receive raw materials and not when payments are made for it. These raw materials are also noted as an expense. Typically, public companies favour the accrual method, which is also in line with the generally accepted accounting principles (GAAP) standards and rules.

Cash basis accounting

Under this accounting method, income and expenses are noted when cash actually changes hands and payments are realised. Revenue and expenses are not included in the company's books unless these payments are received or made. This method is usually preferred by individuals running a business and smaller companies.

How do profit and loss statements work?

Along with the cash flow statement and the balance sheet, every public company issues a profit and loss statement each year. It is a significantly important document for investors and other companies as well. For many, it is perhaps the most important of the three as it directly gives insights into a company’s profitability and bottom line.

Profit and loss statements can also be referred to with different terms and names, including statement of operations, expense statements, earnings statements, statement of financial results, statement of income, and income statements.

The profit and loss statement specifically contains the changes in accounts in a given period. Compared to this, a balance sheet lays down a business’s assets and liabilities. An important thing to note here is that due to the accrual method of accounting being popular with public companies, the profit and loss statement could very well differ from the cash flow statement. Thus, it becomes vital to study them both together to get a clearer overall picture of the company’s performance.

The P&L statement starts by noting revenue, also called the top line. Then, expenses, including operating expenses, COGS, interest expenses, and tax expenses, are deducted from it. What we get after this is the bottom line, or the net income, which is the company’s profits.

Also read: What is a commingled fund?

Should P&L statements be considered before investing in mutual funds?

A profit and loss statement is an important fact sheet that must be considered before investing in mutual funds. It will help you assess the performance of the mutual funds during different periods and let you know when to withdraw your investment from mutual funds. Thus, you can use the information provided in the P&L statement to make an informed decision about the investment period and tenure.

Also, when you know and understand the profit and loss statement of a mutual fund, you will know the performance of your investment and will be able to decide about investing and the choice of fund.

Conclusion

Now that you know the P&L statement’s meaning, its importance and relevance in your investing journey, and how it is essential, you can use it to make informed decisions at various stages of your investments. You must use this statement to make better investment choices.

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Frequently asked questions

Why Are Profit and Loss (P&L) Statements Important?

Profit and loss statements are important because these fact-sheets provide vital information about the profit or loss made by a company.

What Is the Difference Between a P&L Statement and a Balance Sheet?

The P&L statement provides information about the revenue, expenses, profit or loss, of a company during a particular time period. On the other hand, a balance sheet is a reference to a company’s financial position as it provides information about the assets and liabilities of a company.

Are All Companies Required to Prepare P&L Statements?

Yes, it is mandatory under law for all companies to prepare and release P&L statements.

What is shown in the statement of profit and loss?

The statement of profit and loss gives a record of a company’s revenue, expenses, profit or loss, during a particular time period.

What is the formula for profit and loss?

The formula for profit and loss is:

Profit = Selling price - Cost price

or, Profit = Total Revenue - Total Expenses

Loss = Cost price - Selling price

or, Loss = Total Expenses - Total Revenue

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Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.