Profit and Loss Statement Concept

It is the ultimate, unequivocal answer to important questions: Are you getting the job done? Are you a successful entrepreneur? Each month you have these questions boldly answered as you look at the bottom line. The profit and loss statement shows the financial performance of the company through the fiscal year and either it is a successful business or not. Companies’ owners look at the income statement at the end of the year as a school boy is looking at his report card at the end of the academic year and according to it he will decide on his future. If the school boy find himself a none successful person in the academic life he will try to enhance his performance and if he failed to do so he will try to change his major or lately to leave the school.

Businesses owners do the same as the school boy, they look at their financial performance at the end of every fiscal year and depending on the results they will decide to continue in the business, divest, invest or harvest the business. The school boy will be asked by his family about his results and upon receiving his report card he will feel threat and the company owner feels the same because his family will ask him the same question.

The Profit and Loss Statement is a financial concept that help owners of a certain company whether their companies are making profits or are incurring losses.The Profit and Loss is simply the difference between the revenues generated from the sales and the total expenses incurred by the company within the same period.Auditors always insist to allocate expenses to the relevant accounting period in order to show the owners the correct figure.Some Finance managers tends to book some expenses on Provisions accounts in order to hide losses and transfer it to future periods so the auditors usually ask for clear supporting documents for any provisions booked in the Ledger in order to tackle such misleading information for the owners of the company.

The Profit and loss statement is divided into the following main categories and under every category you can put as much details as you want.

  • Revenues (Sales Revenues , Service revenue,extraordinary revenues….)
  • Cost of Sales (This item can be calculated through the following golden formula Ending Inventory=Beginning Inventory + Purchases – COS) in other words the Cost of Sales is the purchases of the period plus the change in inventory balance of the period).
  • General and Administration Expenses like Salaries, rent fees,bonuses,travel expense
  • Financing expenses like bank charges,bank interest and currency difference of exchange
  • Taxes and Municipality fees

Income statements for Groups are somehow different in presentation from small companies due to the need for consolidated or combined financial statements.Profit and Loss statement nowadays are used for analytical purposes and for decision making for the management so the management is requesting Finance people to prepare comparative Profit and Loss showing not only the period results but last period figures , last year figures and budget figures.The management also request variance analysis for the variances in the comparative figures and provide explanations for these variances between actual figures of the current period and the budget figures of the same period in addition to the variances between current period figures compared to last year figures of the same period if exist.

Financial Analysts look first at the profit and loss statement as a first step in their valuation process of the performance of any company.There are basic figures that they should look at in order to base their opinion about the company performance.First of all the Total revenues figure show the total turnover of the company which somehow give the analyst an idea about the volume of the company but it should be linked also to the unit sold (some companies are dealing with Fast Moving Consumer Goods) in order to know the value of the unit sold , the second indicator to look at is the Cost of Goods Sold and hence the Gross profit which is also very important and do the benchmark to the industry gross profit.For example,if you are analyzing an automotive company the gross profit should be relatively 20% which is the logical one in this industry so this company should not show a gross profit of 35% or 5% because it is not logical from our experience in this industry.The conclusion from this practice that the type of industry of such company should help the analyst in his evaluation process.

The administrative expenses also should be analyzed in the valuation process because these expenses should not be overweight compared to the company turnover otherwise it will affect the bottom line in the profit and loss statement and may lead to losses which are hard to be recovered which is either through increase the turnover or minimizing unnecessary administrative expenses.The third part to look at is the financing part in the profit and loss statement because it help the analyst to know if the company is financing its operations through the cash generated from its operations or through bank borrowings.

Modern Profit and lost statement also are requested from Finance people by Cost Center i.e by department for budget control purpose.They may ask for profit and loss statements breakdown by activity especially if the company has several profit centers or selling different brands and the management want to know each branch profitability or losses so the management can take corrective actions or take decision to stop a certain product line.