A profit and loss statement (P&L) or the income statement is a financial report which shows the company’s revenue, expenses and profit/loss during a given period of time. The profit and loss statement shows the company’s ability to generate sales through which they generate revenue, manage expenses and create profit. It is based on accounting principles such as revenue recognition, matching and accruals.
The profit and loss statement tells whether a company is profitable or not and it is the document which investors would check to analyse a company’s profit for a given time and would compare it with the industry averages so as to check if the company is operating effectively and generating enough profits. The profit and loss statement is also used to prepare various financial ratios such as gross profit margin, net profit margin etc which is also used to analyse a company’s performance. The revenue over a given period is matched with the expenses over that period to ascertain profit or loss for the given period.
The main categories that include in P&L statements are revenue, direct expenses (cost of sales), selling and administrative expenses, advertising expenses, interest expense, taxes, depreciation and net income. Revenue which is also known as the top-line of P&L statements is the money generated from sales of products and services. The expenses in the P&L statement can be direct and indirect. The direct expenses are also known as cost of goods sold and these are the costs incurred to make the product and to deliver the product. When we deduct the direct expenses from revenue, we get the gross profit/loss.
The indirect expenses include advertising and marketing expenses, rent, salaries etc which are incurred in the normal course of business. Then comes the interest payments on loans taken by the company. Other expenses include depreciation and amortization which are expenses associated with the company’s assets. Over time, the value of the company’s assets decreases and these are known as depreciation and amortization. Then there are tax payments to the government which is an expense for the company.
The indirect expenses (operating expenses), interest payments, depreciation and taxes are deducted from the gross profit/loss to get the net profit/loss of the company over a given period of time which is also known as the bottom line of P&L statement.