How to read a profit and loss statement

It helps gauge the financial performance of a company

Are you from a non-financial background, struggling to understand the financial statement of a company? Fret not, here we explain one of the important parts of a financial statement, the statement of profit and loss (SoPL). This presents the income earned and the expenses incurred by a company, giving a glimpse of its performance during a particular period.

To facilitate instant comparison, most companies present the figures for the previous reporting period, too, alongside the latest numbers.

Income

The first and foremost part of an SoPL is total income. It includes revenue from operations — income generated from the day-to-day business operations of the company — and ‘other income’. The operating income does not include income earned on investments made by the company or other avenues not directly related to the business. Such income will be grouped under other income. For instance, other income of Hindustan Unilever for FY18 included interest income of ₹136 crore on investments in bank deposits.

Expenses

Next comes the expenses part. All costs incurred by the company (except tax and exceptional costs) are categorised according to their nature, and only the significant items are presented as line items. The rest of the costs are clubbed under ‘other expenses’. For example, as the cost incurred on software licences is vital to the IT industry, companies such as TCS and Infosys show it separately under the expenses head. In the same way, real estate companies show cost of land-stock purchased separately as it constitutes a notable portion of their total expenses.

As per Schedule III of the Companies Act, 2013, companies are mandated to show employee benefit expenses, finance costs and depreciation, separately. Manufacturing companies ought to show the cost incurred on producing goods, such as cost of raw materials and purchase cost of traded goods.

Deducting the total expense from the total income gives ‘profit before exceptional and extraordinary items and tax’.

But, if you want to know the EBITDA (earnings before interest, tax, depreciation and amortisation) of a company, add the depreciation and finance cost to the above profit. Dividing EBITDA by revenue will give EBITDA margin, a term often used to gauge the profitability of operations.

Extraordinary items

Extraordinary items are those unexpected gains or losses that are not directly related to the ordinary business dealings of a company and are non-recurring in nature. For example, it can include losses from disastrous events such as an earthquake.

Whereas, exceptional items are those that are related to the ordinary business of the company but needs a special disclosure owing to the size and nature of the item. For example, HUL’s SoPL included exceptional income of ₹46 crore in FY18, which was the profit gained on the disposal of one of its joint ventures.

These items are shown separately so that investors can understand that the profits reported by the company are not derived entirely from the normal operations, and includes one-off items.

Deducting or adding these items to the above-mentioned profit gives Profit Before Tax (PBT). Deducting the taxes from the PBT, leads to Profit After Tax (PAT), which is considered the bottomline of a company for a particular period.

Sometimes, when a company has discontinued a part of its operations, profit/loss from that segment will be disclosed separately. This item is to be appraised by the investor because the profit/loss from that particular segment will no longer be contributed to the company in the future.

Another segment of an SoPL is ‘other comprehensive income’. It includes those incomes and losses that were not recognised in the calculation of PAT, such as the gains/losses arising from translating the financial statements of foreign operations.

Banking companies

While Companies Act, mandates the above-stated format for presenting an SoPL, banking companies are exempt from it. It follows the ‘income - expenditure = profit’ format. While income includes interest earned on loans given, expenditure consists of interest paid on deposits, operating expenses, and provisions and contingencies.

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