How to read and easily conduct a P&L analysis 

What is a P&L statement?

A profit and loss statement, also known as an income statement, is a critical tool in financial statement analysis that helps evaluate a company's performance over a specified period. The P&L report separates operating revenue from operating expenses and provides metrics like gross profit margin, net income, and earnings per share (EPS).

Both public and private companies use this information to determine how well their sales, marketing, and operations strategies work. But, publicly traded companies are obligated to reveal their financial statements to their stockholders so that they're able to assess a company's financial health.

Knowing how to read and use your P&L to evaluate your financial position will help you understand your company's income streams, how and where you're spending your money, and what you can do to improve your company's performance.

What does an income statement show?

A profit and loss statement is a financial report that shows a company's revenue, expenses, and net income or loss over a period. The P&L statement can assess a company's financial performance and determine its financial performance for a given fiscal year.

The bottom line of the financial statement is net income, which is the difference between the total revenue recognition principle and total expenses incurred (including taxes).

Net sales

To find your net sales, start with your gross sales and subtract any returns, allowances, or discounts. Doing so will give you your net sales

Total cost of goods sold

Next, calculate your cost of goods sold (COGS). COGS is the cost of the goods or services you sell.

To find your COGS, add the cost of the materials used to make your product, the labor involved in making it, and any other direct costs associated with selling it.

Gross profit

The gross profit is the direct result of your company's sales minus the COGS.

To calculate your gross profit, use the formula below. 

Revenue - COGS = Gross profit

You can also use this number to calculate your gross profit operating margin. Divide your gross profit by your total revenue and multiply it by 100%. A positive net operating profit margin means that you have a profitable business, while a negative one indicates that you are in the red.

Operating expenses

The next step is to calculate your operating expenses. It is your company's total amount of money on its day-to-day operations.

Operating revenue - Operating expenses = Operating income. 

You must gather data from your company's financial records to calculate this.

Now that you have your operating income, you can begin to analyze it. One important thing to look at is your company's cash flow statement.

Depreciation & amortization

Depreciation and amortization are two essential line items on a company's profit and loss statement. They both represent a company's non-cash expenses used to generate revenue.

Depreciation is a cash basis accounting procedure that spreads out an asset's cost over its useful life, while amortization is an accounting procedure that applies to intangible assets.

The idea behind depreciation is to record the cost of capital assets as they wear out and become less valuable over time. 

Amortization spreads out these costs more evenly to avoid distorting income statements with significant upfront costs.

Interest expense

The next thing you need to do when analyzing a profit and loss statement is to understand what each line item on the statement means. The interest expense is the amount of money that the company pays in interest on loans. 

This number can be found on the income statement and is usually listed as a separate line item. The interest payments can be divided into interest paid on loans from financial institutions and interest paid on other loans.

Income tax expense (current tax expense + deferred tax expense - deferred tax asset)

A company's income tax expense (current tax expense + deferred tax expense - deferred tax asset) is the amount of money the company owes in taxes. The current tax expense is the amount of taxes owed for the current year.

The deferred tax expense is the amount of taxes owed in future years. The deferred tax asset is the amount of taxes that will be refunded to the company in the coming years. The expense of income taxes for a company can be found on its profit and loss (P&L) statement.

Net income/(loss)

The next thing you need to do when analyzing a profit and loss statement is to find the net profit/(loss). This figure will give you an idea of whether the company is making or losing money.

To find the net profit/(loss), take the total revenue and subtract the total expenses. If the number is positive, then the company is making money. If the number is negative, then the company is losing money.

How to perform a P&L analysis

Do not let all those numbers intimidate you. As a founder, here's what you should look for when analyzing your profit and loss statement.

Pay close attention to your net revenue

If your net profit margin is positive, that's excellent news. However, if not, do not worry. Amazon, for years, was famously unprofitable. So a net loss is not always a bad sign.

If you're a new company and you see that you are in the red, it is an opportunity to optimize your expenses and develop strategies to improve revenue so you do not stay in the red.

Look at your company's revenues and expenses

Ask yourself these questions

  • Is your revenue growing?
  • Is the increase a one-off, or can it be repeated?
  • Do your fixed and variable expenses make sense? Is there an expense that is larger than it should be?

Once again, it is an opportunity to optimize expenses and brainstorm strategies to improve revenue.

Final thoughts on the profit and loss statement

A profit and loss statement is essential for any business owner or manager. Understanding how to read and analyze a P&L statement can make informed decisions about where to cut costs and how to increase revenue. While it may seem daunting at first, once you get the hang of it, analyzing your P&L will become second nature. 

Make sure to ask yourself these questions:

  • What are my company's gross profit margins?
  • What are my company's ability operating expenses?
  • Are there areas that I could improve to increase profits? For example, have I been overpaying on rent, paying too much for supplies, or not paying enough employees what they're worth?
  • Is my product priced competitively in the marketplace?
  • Am I getting a good return on investment from my marketing efforts?

Once you find out your company's profit margin, which should be listed in the Income Statement document of your financial statements, you can determine whether it needs improvement by comparing it to other companies within your industry.

Suppose other companies are making more money off their products than yours. In that case, this may be due to poor pricing or a lack of promotional strategy.

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