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Profit and Loss Statement

A step-by-step break up of how to study P&L/Income statements starting from revenues all the way down to schedules & notes to the accounts.

Gopal Kavalireddi
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Also referred to as the P&L Statement or an Income Statement, it indicates the business activities undertaken by the company, translated into financials, for easy understanding and representation, for a particular time period. The time periods normally used are quarterly, half-yearly and annually. In simple terms, it highlights the profit or loss achieved by the company due to its business activities.

The broad segments of the profit and loss statement for each company remain the same but the expense description varies from a manufacturing company to a service firm to a bank. In a service-oriented company, the spend on manpower is the biggest expense, whereas, for a manufacturing company, the raw material cost is the dominant expense. Understanding the order of the items in the P&L is essential in grasping the operations of the company, during any particular time frame.

For Prakash Industries. a manufacturing company, the P&L statement for the Oct-Dec quarter is illustrated as follows:

pl_statement_illustration

In order to understand the growth or the progress of the company, the financials are compared either on a Y-O-Y basis or a Q-O-Q basis. Y-O-Y comparison implies comparing the performance of the current quarter of the current year with the same quarter of the preceding year and Q-O-Q basis relates to the comparison of the performance of the current quarter with the previous quarter of the same year.

 

Revenue from Operations

The first item of any P&L statement refers to the revenue generated from the sale of goods/services by the company during that time period. Often referred to as Operating Income, this is the amount received by the company, net of any discounts and returns, after the production and sale of goods or services to either a distributor or a dealer or the end customer.

In the case of Business to Business (B2B) Model of working, the company sells its products to institutions or other companies and in the case of Business to Customer (B2C) Model, the company sells its products to the end user directly. This revenue or income relates to the main business or operations of the company. Higher the revenue from operations across various quarters, better is the operational growth of the company.

 

Other Income

Any income received by the company which is not related to the main operations of the company is termed as Other Income. The sources for other income can be from,

  1. the profit arising out of the sale of any assets or investments, and

  2. foreign exchange gains arising due to currency fluctuations, and

  3. rental income from the company’s commercial and other buildings, and

  4. any dividends received due to its financial investments in the shares of other companies, and

  5. interest received on the cash and cash equivalents deposited in the bank or loans given to other entities.

This is not the main income of the company, also termed as Non-Operational Income and is usually small as compared to the operating income generated by the business activities of the company.

 

Total Income

Total Income is the sum total of the operational income and the non-operational income of the company. This is the total revenue generated by the company through all the available sources.

 

Expenses

The amount of money spent on producing and selling the goods of the company is termed as Expenses of the Company. This item encompasses all the categories of expenses incurred for generating the total income of the company.

All expenses are segregated as fixed expenses and variable expenses.

  1. Fixed expenses or costs don’t fluctuate with changes in production level or sales volume. They include expenses like rent, insurance, equipment leases, payments on loans, depreciation, management salaries, and advertising.

  2. Variable expenses or costs are those that correspond directly and proportionately to changes in activity level or volume, such as raw materials, production wages, sales commissions, inventory, packaging supplies, and shipping costs.

The various categories of expenses are termed as follows:

  1. Cost of Material Consumed – This is the cost of procuring the raw materials and other items and using the manpower to convert them into finished goods of the company. Also, referred to as Cost of Goods Sold (COGS), this is the single largest expense for a manufacturing company, comprising of the material costs, direct labor costs and overheads. In the case of a service company, it would be the employee benefit expenses which occupies the top position amongst the expenses.

  2. Change in inventory of finished goods and work in trade – Inventory refers to availability of finished goods at any time, and change in inventory of finished goods refers to the cost incurred for producing goods at an earlier time, but have been sold in the current reporting period. Work in trade refers to the materials available in the production, which have not yet been converted into finished goods. A negative number in inventories of finished goods and work in trade means the closing inventories is less than the opening inventories and vice versa. Depending upon the demand-supply scenario, each company maintains an inventory, increasing or decreasing it from time to time.

  3. Employee Benefit Expenses – Expenses incurred by a company due to an employee rendering services is termed as Employee Benefit Expenses, which can be in various forms – wages, salaries, security contributions, paid leaves, profit sharing and bonuses, non-monetary benefits (such as medical care, housing, cars and free or subsidised goods or services), post-employment benefits like pension, insurance, medicare , gratuity, disability benefits and termination benefits. These expenses are a small portion for a manufacturing company while they are highest for a service oriented company.

  4.  Finance Costs – The company borrows money either on a short-term basis for needs like working capital or on a long-term basis for needs like capital expansion (Capex) for which the company has to pay the interest on a periodic basis. These costs are termed as Finance Costs.

    The interest paid on the debt of the company’s borrowings (secured and unsecured loans) inclusive of all bank charges are termed as Finance costs. Interest is normally paid on the inter-corporate loans, fixed deposits from the public, term loans availed for the purchased of fixed assets, bank overdrafts etc. Higher the debt on the books, higher the finance costs. If the business is growing at a faster pace, then the company will not have in paying the interest costs. However, in times of downturn, the interest costs can become a burden if the operating profit is not sufficient enough to cover the interest costs.

  5. Depreciation and Amortization Expenses – Assets can be classified into two types: Tangible Assets like buildings, machinery, office equipment etc., which can be subjected to wear & tear over a period of time & Intangible Assets like goodwill, patents, copyrights, trademarks etc. whose value is not based on the physical form, but provide necessary contribution to the business of the company. Both, depreciation and amortization are non-cash based expenses.

    1. Depreciation is a measure of decrease in value of tangible assets over a period of time. There are two methods of depreciating assets: the most commonly used is the Straight Line Method and, the Accelerated Depreciation Method, which is based on the govt. regulations and provisions. Straight line method of depreciation simply divides the cost of the asset by the time period of its useful life. While accelerated depreciation, is based on the govt. legislation, allowing the businesses to quickly depreciate the expenses, where a higher percentage of depreciation expense is allowed to be deducted in the earlier years.

    2. Amortization is the expense incurred by the use of intangible assets over a period of time, which is calculated by dividing the initial cost of the intangible asset by the estimated useful life of the intangible asset. Amortization is calculated in the similar manner as the straight-line method of depreciation.

  6. Excise Duty Expenses – Also called as government levies, the indirect tax which is levied on manufacture of goods produced within India, is termed as Excise Duty and is expensed under this head. However, after the introduction of the Goods and Service Tax (GST), all indirect taxes are subsumed under the GST and these expenses have ceased to exist separately.

  7. ​​​​​​Other Expenses – All expenses which are not categorized in the above expenses are termed as Other Expenses, which include miscellaneous expenses, donations, loss on sale of fixed assets or investments etc.

  8. Contingent Liabilities – With an uncertainty of an event happening, which can have a negative impact on the profit or loss of a company, it is essential to record the possible liabilities through appropriate provisioning. Since these liabilities are contingent on the occurrence of an event at a future point in time, they are recorded as Contingent Liabilities and marked as an expense in the P&L and a liability on the Balance Sheet.

 

Total Expenses

Items 1, 2, & 3 are termed as operating expenses as they relate directly to the core operation of production of goods and items 4, 5, 6, and 7 are termed as non-operating expenses, as they are support expenses and not directly related to the main operations. The sum of all the operating and non-operating expenses are termed as Total Expenses.

Lower the expenses, better is the cost management (control) of the company.

 

Profit Before Exceptional Items and Tax

Also referred to as Earnings/Net Income before exceptional items and Tax, this is calculated as the Total Expenses of the company deducted from the Total Revenues of the company.

Total Revenue – Total Expenses = Earnings or Profit before Tax (and before exceptional items).

Higher the EBT(PBT), better is the performance of the company.

 

Exceptional Items

Exceptional items are expenses and/or income, which arise from the normal operations of any business but are not within the usual range. These items don’t feature regularly on the income statement but are disclosed in the balance sheet and are one-off in nature. These items can include losses due to labor disputes, large amount of bad debts, business restructuring costs, legal or tax or insurance claim settlements, reversals of provisions, disposal of non-current or long-term assets or investments, write down of inventory due to various reasons.

 

Profit Before Tax

Denoted as PBT and also referred to as Earnings before Tax, it is the sum total of exceptional items and the profit before exceptional items and tax. Higher the PBT, higher is the growth in the profit of the company before tax.

EBT(PBT) = Earnings before Tax ± Exceptional Items.    

 

Tax Expense

An expense incurred by the company in earning profit which is accrued in the same period as revenue & expenses, is termed as Tax Expense. To understand tax expense better, it is necessary to define certain terms, as given below:

  1. Accounting income (loss) is the net profit or loss for a period, before deducting income tax expense or adding income tax saving.

  2. Taxable income (tax loss) is the amount of the income (loss) for a period, determined in accordance with the tax laws & rates, based upon which income tax payable (recoverable) is determined.

Tax expense (tax saving) is the aggregate of current tax and deferred tax charged or credited to the statement of profit and loss for the period.

  1. Current tax is the amount of income tax determined to be payable (recoverable) in respect of the taxable income (tax loss) for a period.

  2. Deferred tax is the tax effect of timing differences. Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods. Permanent differences are the differences between taxable income and accounting income for a period that originate in one period and do not reverse subsequently.

 

Profit after Tax

Denoted as PAT, it is the profit earned by the company after paying the tax. It is termed as Net Profit earned by deducting all expenses from the total revenue earned by the company. It is the measure of profitability, where higher PAT indicates the directional growth of the company, from which the dividends are paid to the shareholders.

EAT(PAT) = Earnings before Tax ± Tax Expense.

 

Extraordinary Items

Extraordinary items categorized are income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the company and, therefore, are not expected to recur frequently or regularly. These items include income from discontinued operations, stake sale in an associated company or a subsidiary, losses due to catastrophic events in nature or weather etc., which are non-recurring in nature.

 

Paid up Equity Share Capital

The total amount of money for which shares were issued to the shareholder, for which payment was made by the shareholder is termed as the Paid-up share capital of a company. Paid up capital will always be less than authorised capital, as a company cannot issue shares above it authorised capital. Also, the shares owned by entities or individuals, not including the promoter or the promoter category is termed as Total Shares Outstanding.

 

Earning Per Share

Earnings per share or EPS is a critical financial parameter indicating the profitability of any company. EPS is calculated by dividing the company's Profit after Tax, with its Total Number of Outstanding Shares. It is the most appropriate and critical indicator used by market participants to gauge the profitability of a company before investing in the company. Higher the EPS, higher is the profitability of the company.

EPS = Net Profit / Total no: of Outstanding Shares.

EPS is of two types:

  1. Basic EPS: In this case, it is computed by dividing the net profit or loss attributable to the equity shareholders of the Company by the weighted average number of Ordinary shares outstanding during the year.

  2. Diluted EPS: In the case, the denominator is the difference, as it takes into account all types of conversions and options. Diluted EPS is calculated on the assumption that, any investor who has a conversion instrument, will convert it into equity at some point in time. This increases the quantity of total number of outstanding shares and dilutes or reduces the earnings per share. The conversion instruments can be stock options, foreign currency convertible bonds etc. Depending upon the outstanding conversion instruments, Diluted EPS is either equal to or less than Basic EPS.

 

Dividends

Of the total profit obtained by the company, some portion of the money is paid to the shareholders which is termed as Dividend. The balance portion of the net profit after payment of dividend is retained by the company is the form of reserves to support any expansion plans through either the organic route or through acquisitions of other businesses. These reserves are also referred to as retaining earnings, as they are the earnings which are retained by the company to support their future plans which can include a buyback of shares or returning to the shareholders as a special dividend. However, there are two main types of dividends – interim dividend and final dividend.  

  1. Interim Dividend: As the name suggests, it is the dividend paid in the interim of a financial year, during the declaration of any quarterly results, but based on the status of the net profits of the company.

  2. Final Dividend: Paid at the end of any financial year, the final dividend is paid as a percentage of the net profits of the company for the completed financial year. This dividend is proposed during the AGM of a company and paid upon approval of the shareholders.

 

Schedules and Notes to the Accounts

The schedules and notes to the accounts are provided to detail certain items as well as provide additional information on the methods or policies followed in compiling the financial statements.

  1. Schedules: The details relevant to information about sales, manufacturing costs, and other items are provided in the Schedules provided in the financial statements. These schedules aid the investor in comparing the increase in expenses and the reasons for the increase. Also included in the schedules is the information related to the company’s installed and production capacities, product portfolio and the corresponding sales of those products. Hence, it is essential to read the schedules to understand the company’s current scenario to be able to relate to the future capex or expansion plans.

  2. Notes: Similar to the Schedules, the Notes to the Accounts are relevant and extremely important as they provide information related to the accounting policies adopted, the contingent liabilities declared and other information which can affect the company’s business and prospects. Accounting principles adopted by a particular company might vary from another’s company’s adopted policies or methods of accounting. The reasons behind a particular asset valuation or categorization of an expense or depreciation, claims of taxes, provisioning for liabilities etc. are indicated in the Notes to Accounts.

As explained in this section, understanding of each item in the profit & loss (income) statement is essential to understanding the operational, financial progress and profitability of any company, from quarter to quarter and year to year. Also, income statement should not be considered in isolation but read in conjunction with the balance sheet, which will be discussed in the following section.

 

Next Chapter

Balance Sheet

9 Lessons

Learn about the Statement of Assets & Liabilities in detail and implications of each item within.

Cash Flow Statement

3 Lessons

It provides an explanation of how the company is able to generate cash and utilize it. Learn how to read the cash flow statement in detail.

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Responses

Samika commented on April 23rd, 2019 at 12:31 PM  
What should be the ideal ratio between Diluted EPS and Basic EPS? Should one be higher than the other and if so, why?


Gopal commented on April 24th, 2019 at 6:56 AM  
There is nothing specific about the ratio between Basic and Diluted EPS.
As mentioned in the topic 'Earnings per Share' above:
Basic EPS is calculated considering only the total shares outstanding, whereas Diluted EPS is calculated taking shares outstanding +preferred shares + ESOP+Warrants etc.
Hence, Diluted EPS can be equal to or less than but never be greater than Basic EPS.


Pooja commented on June 4th, 2019 at 6:22 PM  
Earning per share is given after tax deduction or before tax deduction and do we need to pay tax on these earnings?


Gopal commented on June 4th, 2019 at 10:26 PM  
Earnings per Share (EPS) is net profit divided by the Total no: of Outstanding Shares.
Net Profit is the profit earned by the company after paying taxes and hence EPS indicated for every company is after payment of taxes.
This EPS is for the company and not for the shareholders. It is an indicator of how much the company is earning per outstanding share.
Out of the total net profit earned by the company a certain portion is earmarked for investors to be paid out as dividend. The company has to pay a dividend distribution tax of 15% excluding surcharge and cess. After the payment, the dividend is distributed to the shareholders based on each investor's shareholding.
You need to pay a 10% tax on dividends earned if the dividend amount accrued from all such sources in a financial year is greater than Rs. 10 lakh. Incase it is less than that amount, then an investor doesn't incur any tax.


R A commented on March 15th, 2020 at 6:12 PM  
Have some doubts, but afraid to shoot it, thinking how juvenile i might sound...
so
no


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