How to Read and Understand a Profit and Loss Statement?
Preparing the Profit and Loss Statement or the P&L Statement is one thing. Reading and understanding it is another. The P&L Statement is a very powerful tool that any owner or reader should take time to read, to understand and to analyze to be able to tap and to utilize the very useful information it contains.
The first step towards understanding the P&L Statement is to know the meaning of profit. Profit is the end result (the ‘bottom line’) of this statement. Earning profit is the reason why one goes into business; it also gives an indication of how well the business is operating and what the owner can expect in the future. Profit is the reward the owner gains from investing his money into the business and is a vital figure in assessing the long-term survival of the company. Without profit, the business will not be able to thrive for long.
Other than profit, it is important to understand the major components of the P&L Statement. Generally, there are five major sections of the P&L Statement. These are the revenues, cost of goods sold, expenses, other income and other expenses.
The amount of revenues shows how much the company was able to earn when it sold its products or services. This figure tells the owner whether his company’s products or services are really selling or not.
The cost of goods sold is applicable only to a company engaged in selling goods. It pertains to the cost of the company in terms of acquiring the goods that will be subsequently sold. For a company engaged in selling goods, this is the most important cost figure. The gross profit (GP), which is revenues less cost of goods sold, indicates the company’s actual gain from selling its goods, before deducting any further expenses.
The company’s expenses pertain to those spent by the company to operate and to administer the business. It includes the salaries of the employees who are with the marketing, finance and administration departments. It also includes payments for rent, utilities, insurance, advertising and communication. The total amount of expenses and the amount of each of the above companies show just how much it costs to fully operate and to run the company.
Gross profit less expenses will generate the operating profit or what remains to the company after paying all of the above expenses.
Other income is income derived by the company from sources other than its normal business activities. This includes interest from the company’s investments or bank deposits and income from the sale of the company’s equipment.
Other expenses are those expenses not normally spent by the company. The most common is interest expense for loans obtained by the company.
The above are the major components of the P&L Statement. After adding other income and deducting other expenses from the operating income, the company now has an income before income taxes. Income taxes, depending on the tax regulations, will then be deducted from this figure to arrive at the profit or the bottom line of the company.