P&L Tutorial (AKA Profit and Loss Statement, Income Statement) - Fervent | Finance Courses, Investing Courses (2024)

The P&L Statement (aka Profit and Loss Statement) is one of the primary financial statements that companies must prepare and publish.In this P&L tutorial / article, you’ll learn the most important aspects of the P&L. Let’s get into it.

Table of Contents hide

1.1 Jargon Buster

3.1 What is the Difference Between Profit and Loss and a Balance Sheet?

3.2 What is the Difference Between Profit and Loss and Income Statement?

3.3 What Expenses Go On A Profit and Loss Statement

4.1 Horizontal Analysis

4.2 Vertical Analysis

4.3 Ratio Analysis

What is the P&L / Profit and Loss Statement?

Like we said earlier, the P&L (aka Profit and Loss Statement) is one of the primary financial statements that companies must prepare and publish.

The P&L shows a firm’sfinancial performancein the context of its:

revenues,
expenses, and
profit

Before we go on any further, let’s get some jargon clear and out of the way.

Jargon Buster

P&L Terminology

The P&L is called a variety of things, including:

Profit and Loss Account
Income Statement
Statement of Income
P&L Statement
P&L Account

While there are minor variations across each of the terms above, they’re allessentially the same thing.

It’s common for people new to accounting to feel rather overwhelmed when they see this barrage of terms.

Rest assured, if you knowone of these terms, then you pretty much understand all of them.

What are the P&L Items?

Broadly speaking, the P&L is made up of three items:

revenues,
expenses, and
profit

Sure, there are a whole host of other items in the P&L. But they’ll all fit into one of these three.

We’ll touch on the other “subitems” as we go further along. But as long as you takeaway the fact that the P&L is largely made up of revenues, expenses, and profit, you’re good to go.

What are Revenues in P&L?

Revenues refer to sales that a company makes.

Think about the time you went into Starbucks to buy a coffee.

The amount you paid goes into Starbucks’ P&L as Sales (or Revenue, or Turnover).

Bought an iPad recently?

That’ll go into Apple Inc.’s Sales or Revenue figure.

Incidentally, you can check out one of Apple Inc.’s P&L statements here.

Now, remember how we said there might be “subitems”?

Well, in that context, you might see Revenues broken down into:

Gross Revenues (aka Gross Sales), and
Net Revenues (aka Net Sales)

You might even find Revenues broken down geographically.

Or across companies and then aggregated as “consolidated” revenues (acrossall companies in a group).

Now, this is getting a tad bit too technical, so we’re gonna leave it at that.

The key takeaway is that Revenues refer to sales that a company makes.

Some describe it as simply the Selling Price multiplied by the number of units sold.

But we find that to be a little too simplistic for the real world. Especially where companies sell different products and services.

But sure,in essence, you can kinda think of it as Selling Price times the number of units sold.

Importantly, trynot to think of it as money the company makes. You’ll thank us later.

For now, let’s think about the other major item in the P&L – expenses.

What are Expenses in P&L?

Expenses refer to the costs and outgoings of a company.

Notice we didn’t describe it as something a companyspends.

While youcould think of a company’s expenses as “expenditure” (what it spends), it’s best not to.

That’s because Expenses also include “non-cash expenses”.

Those are expenses where no money goes out.

We’re not making this up, promise.

This is one contributing factor of accounting scandals and the like.

It’s a tricky little thing called “accrual accounting”, which results in ‘expenses’ comprising of things where no money has been used/spent.

To add to the confusion, though, expenses also include items where money has actually been spent.

And that’s why we said youcould think of expenses as “expenditure” (or what a company spends). But it’s best not to do so.

You’ll thank us for that, too.

The key takeaway, at this stage, is that Expenses refer to costs and outgoings of a company.

Okay, let’s now think about the final item in the P&L – profit.

What is Profit in P&L?

Profit reflects the income that a company earns.

Importantly, profit is NOT the same as cash (nor is it cash flow).

RELATED: Cash Flow vs Net Income

Simply put, profit is equal to Revenues minus Expenses.

That is…

Profit = Revenues – Expenses

Take all of a company’s Sales. Subtract all of its Expenses. And you have Profit.

Remember we said there’s some more important jargon in the context of the P&L?

Yeah, that’s in the context of Profit.

If we think of Profit as Total Revenues minus Total Expenses, then we can also describe it as…

Net Profit
Net Income
Total Income
Total Profit
Earnings
Net Earnings
Earnings After Tax
Profit After Tax
Net Profit After Tax

They all mean the same thing.

Entertainingly painful, isn’t it? Accountants really do love their jargon.

Importantly, the point about the synonyms is only true if we’re thinking about Profit as Total Revenues minus Total Expenses.

There areother forms of profit, including:

Gross Profit
Operating Profit, AKA:
- Earnings Before Interest and Tax
- EBIT
- Profit Before Interest and Tax
- PBIT
- Profit from Operations
Earnings Before Tax (aka EBT, PBT)

Sigh, that’s a lot of jargon. Someone should really tell the accountants it’s time to stop eh?

Anyway, hopefully, you now know what the P&L is, and what the P&L items are.

Despite the terms, and all jokes aside, there is a method to the madness. Do check out our sister article on the accounting processfor more on that.

Understanding the P&L / Profit and Loss Statement

Let’s now dive deeper into the intricacies of the P&L / Profit and Loss Statement.

What is the Difference Between Profit and Loss and a Balance Sheet?

A Profit and Loss (or P&L) focuses on and displays a firm’sfinancial performance in the context of its revenues, expenses, and profit.

A Balance Sheet, on the other hand, focuses on and displays a firm’sfinancial performance in the context of its assets, liabilities, and equity.

RELATED: What Is The Accounting Equation And Why Does It Work?

Both financial statements are related to one another, but they are distinct and unique in their own right.

A Balance Sheet is sort of “static” in that it shows us a firm’s assets, liabilities, and equityat a specific point in time.

It’s sometimes referred to as a “snapshot” of the business and its financial health. Or a photograph of the business at a specific point in time.

The P&L on the other hand is somewhat more dynamic.

It shows us a firm’s revenues, expenses, and profitover a specific period of time.

There’s a hint / nudge about this in the way the financial statement titles are written out, too.

For instance, the Income Statement is typically written out as:

“XYZ Company Income Statement For The Year Ending 31 March 20X1”

The Balance Sheet on the other hand, is typically written out as:

“XYZ Company Balance Sheet As At 31 March 20X1”

Notice the difference?For the year ending vsAs at?

Again, the Income Statement reflects the financial performanceover a period of time.

And the Balance Sheet reflects the financial positionat a specific point in time.

What is the Difference Between Profit and Loss and Income Statement?

There is no real difference between Profit and Loss and the Income Statement.

Trick question this.

Remember our jargon buster from the top?

The Income Statement is just a synonym for the P&L.

If you’re wondering why there are so many different terms for the same thing, it’s just to do with time and evolution.

Over time, accountants have changed terms to try and better reflect what the terms are about.

But old habits die hard. People don’t like change. Thus, many people continue to use the older terms (P&L instead of Income Statement, for example).

It’s no surprise that many people still wonder “is P&L the same as Income Statement?”.

For the record, yes – yes it is.

The differences aretypically to do with time or in some cases, accounting standards.

For example, one country’s Accounting Standards may call it “Profit and Loss Statement” while another’s might call it “Statement of Income”.

But they’ll both show you the same thing – a firm’s financial performance in the context of its revenues, expenses, and profit.

What Expenses Go On A Profit and Loss Statement

Broadly speaking, we can think of two kinds of expenses that go on a Profit and Loss Statement, including:

Cost of Sales (or Cost of Goods Sold), and
All other expenses

Cost of Sales (or Cost of Goods Sold)

Cost of Sales (or Cost of Goods Sold) refers to the costs that, if not incurred, will mean no sales are possible.

For example, for Starbucks to sell you coffee, they need to actually have that coffee available.

To have and sell the coffee, they need to have:

(hopefully) fresh coffee beans
hot water
a cup*

Without either of these 3 items, they can’t sell you a coffee!

These 3 items are needed in order to make the sale.

Thus, they can be treated as “Cost of Sales”.

* Now, when it comes to the cup, onemight argue that takeaway cups should be treated differently vis-a-vis in-store cups.

That’s because the takeaway cups can only really be used once, while the in-store cups can be reused many times.

Cup technicalities aside, the key takeaway, for now, is that Cost of Sales refers to the costs that, if not incurred, will mean no sales are possible.

Put differently, Cost of Sales reflect the direct cost of making a sale.

We intentionally avoided the term “direct cost” however, since that term is used within Management Accounting settings. And it’s a slightly different concept.

All Other Expenses

Any costs or outgoings that, if not incurred, won’t necessarily mean no sales are possible, can be deemed as “all other expenses”.

These include (but aren’t limited to):

marketing and advertising
salaries and wages
rent and rates (theycould just “Deliveroo it”, for example)
administrative expenses
utilities (e.g., gas, electricity, wifi, etc)
insurance
depreciation (a non-cash expense)
amortisation (another non-cash expense)

Put simply,any expense that, if not incurred, won’t necessarily mean no sales are possible, can be deemed as “all other expenses”, and will show go in the Profit and Loss Statement.

How Do You Calculate Profit on the P&L?

In its simplest form, profit on the P&L is calculated as:

Profit = Revenue – Expenses

This is the same as saying:

Net Income = Sales – Expenses

(see Jargon Busters above).

There are, however, other types of Profit (as we talked about earlier).

And these are calculated slightly differently. But the underlying approach – revenues minus expenses – remains unchanged.

Let’s think about how the different types of profit are calculated on the P&L.

Calculating Gross Profit on the P&L

Gross Profit = Revenue – Cost of Sales (or Cost of Goods Sold)

You can think of Gross Profit as the profit that’s available to fund “All Other Expenses” in the P&L.

Calculating Operating Profit on the P&L

Operating Profit (aka Earnings Before Interest and Tax) is calculated as:

Operating Profit = Revenue – Cost of Sales – Operating Expenses

But you said there were only “Cost of Sales” and “All Other Expenses”! What’s this “Operating Expenses”?

We didn’t want to overwhelm you. It’s not too complicated though.

You can think of Operating Expenses as the expenses that directly relate to the operations of the business.

They’re still expenses that, if not incurred, won’t necessarily mean no sales are possible.

But they relate explicitly to the operations of the business. They’re inside the businesses control.

So tax, for example, wouldnot be an operating expense.

Because that’s not under the businesses direct control, for instance.

Thus, again, here’s the Operating Profit Formula:

Operating Profit = Revenue – Cost of Sales – Operating Expenses

And note again that Operating Profit is also called…

Earnings Before Interest and Tax
EBIT
Profit Before Interest and Tax
Profit from Operations

Calculating Earnings Before Tax on the P&L

Earnings Before Interest and Tax (aka EBT) is calculated as…

EBT = Revenue – Cost of Sales – Operating Expenses – Interest Expense

All starting to make sense now?

If not, start reading this main section again (from “How Do You Calculate Profit on the P&L?”).

Calculating Net Profit on the P&L

Remember how we said thatin its simplest form, profit on the P&L is calculated as:

Profit = Revenue – Expenses

Well, here’s the expanded form…

Profit = Revenue – Cost of Sales – Operating Expenses – Interest Expense – Tax

That’s clearer now, isn’t it?

If not, you really should start reading this main section again (from “How Do You Calculate Profit on the P&L?”).

How Do You Analyse a Profit and Loss Statement (P&L)?

Like with most types of analysis, there are many different ways.

But, broadly speaking, there are 3 main ways to analyse a Profit and Loss Statement, including:

horizontal analysis
vertical analysis
ratio analysis

Horizontal Analysis

With horizontal analysis, we analyse a Profit and Loss Statement by comparing P&Ls over different years.

So, for example, you might look at the Sales of XYZ company over the following years:

20X1: $3.1bn
20X2: $4.2bn
20X3: $4.7bn

Looking at the numbers by themselves, we can see that this firm’s revenues are rising.

But what about the growth rate each year?

From 20X1 to 20X2, the company’s sales grew by approximately 35.48% ($4.2bn / $3.1bn – 1 ~= 35.48%)

From 20X2 to 20X3 however, the company’s sales only grew by approximately 11.90% ($4.7bn / $4.2bn – 1 ~= 11.09%).

This simple horizontal analysis shows us that the company’s growth in sales has slowed down, despite the overall increase in revenues.

Vertical Analysis

Sometimes also referred to as “margin analysis”, vertical analysis typically expresses an entire P&L in percentage terms.

We take all items inside the P&L in a given year, and divide it by the Revenues of that same year.

So, for example, let’s say XYZ company had the following figures in its Income Statement in 20X3…

Sales: $4.7bn
Cost of Sales: $1.3bn
Gross Profit: $3.4bn
Operating Expenses: $2.8bn
EBIT: $0.6bn
Tax: $0.12bn
Net Income: $0.48bn

We could express the same figures “vertically”, or in percentage terms as…

Sales: 100.00%
Cost of Sales: 27.66%
Gross Profit: 72.34%
Operating Expenses: 59.57%
EBIT: 12.77%
Tax: 2.55%
Net Income: 10.21%

By expressing the P&L this way, we can make the following observations…

XYZ company makes about 10.21 cents for every $1 of sales
the company pays approximately 2.55 cents for every $1 of sales
in 20X3, XYZ company made a gross margni of 72.34%
XYZ company’s net profit margin is equal to 10.21%
its operating margin is equal to 12.77%

We could slice and dice these figures in more ways and make more meaningful interpretations.

But in this context, the key takeaway is that vertical analysis expresses the entire P&L in percentage terms.

Everything is expressed relative to Sales (aka Revenues, aka Turnover).

You getting used to the jargon now?

Good. Let’s think about the final type of analysis then.

Ratio Analysis

This is probably one of the most popular types of analysis.

And believe it or not, we’ve already touched on this!

Common P&L ratios include:

Gross Profit Margin (aka Gross Margin)
Operating Profit Margin (aka Operating Margin)
Net Profit Margin (aka Net Margin, Profit Margin)

In each of these cases, we take the relevant profit (e.g., Gross Profit for Gross Profit Margin) and divide it by Sales.

That’s it.

So…

Net Profit Margin = Net Profit / Sales

Operating Profit Margin = Operating Profit / Sales

You get the idea.

There are some other types of ratios, too. For instance:

Return on Equity
Return on Assets

These are 2 incredibly popular ratios.

But they don’t just rely on the P&L. They also require items from the Balance Sheet.

Remember how we said that the Income Staement and Balance Sheet are distinct yet related?

This kinda reinforces that point.

It’s common practice – and indeed, good practice – to look atall financial statements together.

(Rather than just one of them by itself).

Wrapping Up – P&L / Profit and Loss Statement

Alright, that’s a wrap for this particular tutorial-style article. It’s a pretty extensive one, eh? And hopefully, a somewhat entertaining one, too.

Many people find accounting rather tedious and boring. We find it interesting and intriguing.

Not just because the subject itself is beautiful, but because a good understanding of Accounting is absolutely crucial to learn finance and investing well.

We hope you found this tutorial useful!