A profit and loss (P&L) statement is a critical piece of information for a company that states whether a company is profitable. Learning to read a P&L report can help you ensure that the company where you work is successful in meeting its financial goals. The P&L lists revenue, expenses and other information to provide insight into the company's performance. In this article, we will discuss what a P&L report is, how to read one and why it's important.
What is a P&L report?
A P&L report contains a company's income and expense information for a specific time. It specifically breaks down revenue and expenses and is a measure of whether a company is profitable. Quarterly profit-and-loss statements compare current information against projected budgets, so a company can track whether it's on pace for a profitable year and how it's performing versus previous years .
Read more: What Is a Profit and Loss Statement?
Who prepares the P&L report?
Who creates a P&L report depends on the structure of the company. The CFO, along with the CEO, likely creates the P&L statement for most publicly traded companies. The top company executives then present the P&L report to board members or company shareholders.
In companies organized by divisions, each one might have its own P&L for which the president is responsible. In such a scenario, the presidents file their P&L's with the CEO, who then might compile an overarching P&L statement for the entire company and present it to the board. In this structure, the company can look at each division to see if it's profitable and whether it's contributing to the overall financial goals of the company.
How to read a P&L report
Use these seven important steps to help you read and analyze a P&L report:
1. Define revenue
The revenue or top-line portion of the P&L report documents company revenue for analysis. Revenue details your income from sales and activity for the reporting period. If a company has diversified revenue streams, the P&L statement might separate each stream and combine them for an overall revenue picture. A structure like this allows executives to evaluate each revenue stream in addition to an overall revenue analysis.
2. Understand expenses
Operating expenses include all the costs associated with running a company, like salaries, benefits, rent and utilities. Direct costs are the cost of creating the tangible product or the cost of goods sold (COGS). For example, if a company makes pens, the plastic and ink that goes into making them is a direct cost. Essentially, COGS is the cost of an inventory item. This category doesn't apply to service-focused companies. An insurance company, for example, isn't creating a tangible product and doesn't have inventory.
3. Calculate gross margin
Some P&L statements include a line listing gross margin, which is direct costs subtracted from revenue. This calculation tells a company how much money they have for operating expenses. A service company without COGS has no direct cost line or gross margin. Instead, the P&L report likely lists the operating expenses and revenue-generating expenses, such as the cost of a sale.
4. Calculate operating income
Operating income, also known as EBITDA (earnings before interest, taxes, depreciation and amortization), is found by subtracting the operating expenses from the gross margin for businesses with COGS. Without COGS, you can subtract operating expenses from revenue.
5. Use budget versus actual for insight
This category allows you to see how well the company is actually performing versus how it was budgeted to perform. If you want to know whether the company is meeting, not meeting or exceeding expectations, this is the category to check. One point of doing a quarterly P&L report is to gauge how a company's year is going and to make changes to the budget if needed. Publicly traded companies use this information to project earnings, and these projections can change throughout the year.
6. Check year-over-year
This category compares moments in time. Seasonality and other factors sometimes cause a company's fiscal quarters to fluctuate. Comparing how the company performed at the same time of year in previous years is one way to determine whether the quarterly earnings are in line with prior years.
For example, the fiscal year might start slowly in the first quarter, but perform much better in the second quarter. If there's a year when there isn't a surge in quarter two, this may tell the company that it might not meet the budget and may need to make up the revenue in quarters three and four.
7. Determine net profit
Determine the net profit by taking the operating income and subtracting taxes, interest on debt, depreciation and amortization. While operating income indicates a company's income related to the expense of running the business, net profit is the bottom line profit number. Each number is valuable in evaluating a company, but the net profit might not fully show a company's health. For example, a company might have a positive cash flow but a negative net profit because of existing debt.
Importance of reading a P&L report accurately
The P&L report is the most fundamental measure of a company's success. It's a report that articulates the company's bottom line. Effective executives can read through a P&L statement and understand the financial health of the business. This is critical information that's conveyed to team members and to board members and shareholders. A P&L report, when read correctly, can not only say whether a business is successful, but it can also provide an important perspective on how the information relates to expectations and prior years.