Profit and loss statement: Meaning, example and how to read it

When evaluating the financial position of a company, the profit and loss statement, also known as the income statement, is likely considered the most reliable data point. This report displays how much revenue a company takes in and how much it spends over a period of time. For investors, managers and entrepreneurs, it is considered critical to interpret this report.

This article will define the profit and loss statement, discuss its importance, review its structure, and explain how it may be a key factor in investment decisions.

Table of contents

• What is a profit and loss statement?
• Importance of profit and loss statement
• Example of a P&L (profit & loss) statement
• How to read a P&L statement?
• Structure of the profit and loss statement
• How often are profit and loss statements calculated?
• Types of P&L statements
• How do you compare P&L statements?
• How to prepare the profit and loss statement (P&L)?
• How do profit and loss statements work?
• Should P&L statements be considered before investing in mutual funds?
• Balance sheet vs profit and loss statement
• What are the limitations of profit and loss accounts?
• Income statement vs profit and loss - are they the same?

What is a profit and loss statement?

A profit and loss statement is a report that summarises the revenues, expenses, and costs of a company over a period of time, indicating whether the company has made a net profit or net loss. This report is typically prepared monthly, quarterly, or yearly and is one of three key financial statements, including the balance sheet and cash flow statement.

Also Read: What is return on investment?

Importance of profit and loss statement

• Performance tracking: It helps evaluate if sales are rising and whether the business is profitable.
• Expense control: By reviewing costs line by line, companies can identify areas where spending is too high.
• Decision-making: Managers might use it to decide on pricing, expansion, or cost-reduction strategies.
• Investor insight: Investors may review profit and loss statements to judge whether a company is worth their capital.
• Compliance: In many jurisdictions, the preparation of a profit and loss statement is mandated by law for companies.

Example of a P&L (profit & loss) statement

Below is an example of a simplified profit and loss statement for a small closely held business for one quarter:

• Revenue/sales: Rs. 50,00,000
• Cost of goods sold (COGS): Rs. 30,00,000
• Gross profit: Rs. 20,00,000
• Expenses incurred in operating the business (salaries, rent, utilities): Rs. 10,00,000
• Operating profit (EBIT): Rs. 10,00,000
• Interest expense: Rs. 1,00,000
• Tax: Rs. 2,70,000
• Net profit: Rs. 6,30,000

This illustrates the flow from revenue down to profit.

*Example for illustrative purposes only.

How to read a P&L statement?

When reviewing a profit and loss statement, you may consider the following approach:

• Look at revenue trends: Are sales growing or falling over time?
• Evaluate gross profit margins: This shows how efficiently the company is producing goods or services. 
• Analyse operating expenses: Compare the levies to revenue. Note, if costs are rising, it will affect the company's profits. 
• Examine net profit margin: This shows the level of profitability the company has in the bottom line. 
• Compare historical data: This could mean tracking from one quarter to another or year on year for patterns on revenues or costs.

Structure of the profit and loss statement

A standard profit and loss statement has:

• Top line: Total revenue or sales.
• Less: Cost of goods sold → Gross profit.
• Less: Operating expenses → Operating profit (EBIT).
• Less: Interest and Taxes → Net Profit (or Loss).

Some P&Ls also show EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation).

How often are profit and loss statements calculated?

• Monthly: For internal performance checks.
• Quarterly: Public companies publish a quarterly profit and loss statement as part of their earnings announcement.
• Annually: A full comprehensive profit and loss statement would typically be included with the annual report, and likely would be an audited process.

The frequency of a profit and loss recapitulation will depend on the size of the business and compliance or investor expectations.

Types of P&L statements

• Single step P&L format: Lists all revenues together and then subtracts all expenses in one simplified flow.
• Multi step P&L format: Breaks profit and loss down into gross profit, operating profit, and net profit.

Large companies and listed entities usually prepare multi step versions.

How do you compare P&L statements?

• Year over year (YoY) comparison can show growth or decline in profitability.
• Quarter over quarter (QoQ) analysis might highlight short-term performance shifts.
• Industry benchmarks: Comparing margins against peers may help judge efficiency.
• Ratio analysis: Profit margins, return on equity, and other ratios may deepen insight.

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

Below are the steps that you may follow to prepare a P&L statement:

• Gather all revenue data.
• Record cost of goods sold.
• Subtract to calculate gross profit.
• Add operating expenses (rent, wages, admin).
• Subtract non-operating items (interest, depreciation).
• Deduct taxes.
• Arrive at net profit or loss.

Accounting software can automate much of this, but accuracy in data entry is considered critical.

How do profit and loss statements work?

The P&L Statement translates daily business transactions into a summary of profitability. If revenues are consistently higher than expenses, the profits accumulate as retained earnings, increasing shareholder value. On the other hand, if losses are continuous, this indicates problems with pricing, costs or demand.

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

Yes, indirectly. Mutual funds invest in shares of companies. Fund houses have analysts who study company profit and loss statements to determine which firms might be profitable, sustainable, and growing. For mutual fund investors, you may not read every company's profit and loss statement, but it may be beneficial to know that the profit and loss statement influences the decisions taken by fund managers.

Balance sheet vs profit and loss statement

• Balance sheet: A snapshot of assets, liabilities, and equity at a specific date.
• Profit and loss statement: A detailed illustration of revenues and expenses over a period.

The two complement each other: balance sheet shows what a company owns and owes, while P&L shows how it earns.

What are the limitations of profit and loss accounts?

• Non-cash expenses: Items like depreciation affect profit but not cash flow.
• Accounting policies: Choices in revenue recognition or expense timing may change outcomes.
• Ignores cash position: A profitable company on paper may face liquidity issues.
• Estimates involved: Provisions for doubtful debts, warranties, etc., reduce precision.

Thus, it is advised to read P&L alongside cash flow and balance sheet.

Income statement vs profit and loss - are they the same?

Yes. ‘Income statement’ and ‘Profit and loss statement’ are two names for the same financial report. Some companies prefer ‘statement of operations’ or ‘statement of earnings’, but the meaning, purpose, and core structure are identical regardless of the name: they summarise revenues, expenses, and profit or loss for a specified period. There is no substantive difference between an income statement and a profit and loss statement; the terms are used interchangeably in accounting and financial reporting.

Also Read: What is a mutual fund?

Conclusion

The profit and loss statement meaning is an official report summarising the profitability of a company. It is considered important for its ability to show whether a business is truly making money. By analysing revenues, costs, and expenses, stakeholders may evaluate efficiency, sustainability, and growth potential. For investors, especially those considering mutual funds, understanding what is profit and loss statement may help interpret how professionals select companies.

FAQs

Why are Profit and Loss (P&L) Statements important?

They measure profitability, aid in decision-making, and may provide investors and regulators with performance transparency.

What is the difference between a P&L Statement and a balance sheet?

P&L shows performance over time; balance sheet shows financial position at a specific point.

Are all companies required to prepare P&L statements?

Yes, most registered companies are required by law to prepare them annually. Listed companies must also publish quarterly statements.

What is shown in the statement of profit and loss?

Revenues, cost of goods sold, operating expenses, interest, taxes, and resulting profit or loss.

What is the formula for profit and loss?

Profit (or Loss) = Total Revenue - Total Expenses.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.

The content herein has been prepared on the basis of publicly available information believed to be reliable. However, Bajaj Finserv Asset Management Ltd. does not guarantee the accuracy of such information, assure its completeness or warrant such information will not be changed. The tax information (if any) in this article is based on current laws and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.