How To Read The PNL Statement

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HOW TO READ THE

The profit-and-loss statement gives a summary of the
income and expenses, and thus profitability, of a business.
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n n n n n n n n n HOW TO READ THE P&L STATEMENT

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Contents
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Introduction
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Understanding Income
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n n n n n n n n n Understanding Expenses
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Understanding Tax and Other Items

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HOW TO READ THE P&L STATEMENT
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Introduction
The profit-and-loss statement gives a summary of the income
and expenses, and thus profitability, of a business.
T
he P&L account (which is officially information about three important numbers:
known as the statement of profit & loss) income, expenses and net profit - which is the
is arguably the most important financial difference between the income and expenses.
statement. This is because it provides key To illustrate the format, we can look at a
financial information about a company’s simplistic P&L of an imaginary trading company,
operational metrics, such as sales, expenses and ABC Limited:
most importantly, the net profit. To get a better Total income: Rs 100
understanding of this vital statement, we need Total expenditure: Rs 70
to know its nature and format. Profit: Rs 30
What is a P&L statement? This P&L indicates that the company, ABC
The P&L statement is a very intuitively designed Limited, made a profit of Rs 30 by spending Rs
financial statement, which gives its readers 70 for producing goods/services and selling the
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same for Rs 100. Although this is a simplified ABC Ltd regularly sells goods to a large retailer
version of a P&L statement, the real world P&L who is facing financial difficulties. Even if the
statement is very much based on similar retailer does not make payments, ABC Ltd will
principles. continue recognising the income and be
Today’s P&L statement begins with the profitable on paper, however, in reality, it could
amount of money earned (also called turnover/ be undergoing a severe financial crunch. Many
revenue/income) and moves on to different electricity-generating companies (gencoms)
types of expenditures incurred suffer a similar fate since
by the company so that the The P&L statement distribution companies
amount of profit can be finally (discoms) delay payments by
calculated. Each of these
gives its readers months, if not years.
entries is further subdivided so information about An important aspect of the
that the readers can have three important P&L statement is that it is
clear, understandable and prepared for a particular
insightful information about
numbers: income, time period. And since all
the company’s financial affairs. expenses and net profit. listed companies come out
with their P&L statements
Other important characteristics every three months (as per SEBI’s regulations),
The most crucial characteristic of the P&L investors must differentiate the quarterly P&L
statement is that it is based on the accrual from the annual P&L.
system of accounting, which means that
transactions are recorded in the time period of Key takeaways
their occurrence, no matter when the underlying Despite its drawbacks, the P&L statement is a
cash is actually exchanged. This concept is best very important financial statement. But investors
understood with an illustration. If our imaginary need to be aware of its drawbacks in order to
company, ABC Ltd, makes a sale of Rs 50 on better understand a company’s financial
March 31, 2021 and receives a cheque dated position. It goes without saying that investors
April 1, 2021, then the sale transaction will still must conduct an in-depth analysis of a
be recorded for the year 2020-21, even though company’s financial statements before deciding
the money would be received only in the year to invest in it. The P&L of every listed company
2021-22. Similarly, if ABC Ltd receives a bill in is freely accessible on Value Research Online.
April 2021 to pay electricity charges for the Details are available under the ‘Financials’ tab.
month of March 2021, then this expense would For instance, the P&L of Reliance Industries,
still be reflected in March, even though the India’s largest company by market capitalisation,
payment was not made in that month. can be found here.
The advantage of using an accrual-based
accounting system is that it ensures that the
transactions in the P&L are more reflective of
underlying operational realities. But the
disadvantage is that it can potentially result in
misleading financial statements, with a wide
divergence between the profit and cash
available. Take for instance a scenario where
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Understanding Income
The income part of the P&L statement tells what a company has
earned from its operations and other sources
A
fter gaining a basic understanding of the timing of the transaction, regardless of when
the P&L statement let us focus a bit the cash is received. For many retail businesses,
more on the ‘income’ part. Here there is no difference in timing, as they receive
investors need to conduct a more in-depth cash from customers immediately at the time of
review of the accounting principles in order to sale. However, for many B2B businesses, there
have a more nuanced view of this important is a significant gap between the sale of a
entry and evaluate a company’s financial product/service and the receipt of the payment
performance. for the same because their customers don’t
always pay on time. Businesses, which supply to
Principle 1: Income ≠ cash the government (such as defence, infrastructure
As explained in the first part of this series, construction, etc.) and those entities that are in
income is calculated by using accrual-based a weak financial position (For example: airports
accounting principles. This means that sale is providing services to cash-strapped airlines and
recorded in the P&L statement on the basis of gencoms supplying electricity to distressed
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discoms) are particularly affected by this. When it comes to recognising long-term

Although the P&L would reflect the total contracts, the complicated nature of accrual
amount of sales, it wouldn’t show how much of accounting makes it a bit more tricky. Companies
the stated income has actually been received. usually follow either the percentage completion
Takeaway: Investors should not presume that method or completed contracts method. In the
all the income shown in the income statement former method, the quantum of income
has actually been received by the company. recognised will be dependent on the percentage
of the work completed, while in the latter,
Principle 2: Operating income is income is only recognised when the contract is
more important than other income fully completed. For example, when a real-
When investors look at the P&L of any company estate company constructs an apartment,
on www.valueresearchonline.com, the total investors must check what method of income
income is classified into two types of entries - recognition is being followed by the company.
operating revenue and other income (the terms Companies, like Ashiana Housing, recognise
revenue and income can be used income only when homes are delivered. So, it
interchangeably). While the former reflects the may seem like their revenues are more uneven
core income from the company’s primary and lumpy (as it is tied to the completion of
business, the latter reflects the their projects) as compared to
income from all other sources,
Figuring out the amount other companies who
which are not directly related recognise revenue as
to the company’s business. of money a company is construction progresses. But it
For example, a car earning is more doesn’t reflect the ground
manufacturer may earn reality and is just a natural
complicated than it
interest from FDs or dividends consequence of their
from shares in other sounds. Therefore, accounting principles.
companies. There could also investors need to Takeaway: Investors must
be a scenario where other always be mindful of the
rigorously examine
income is purely an differences in accounting
accounting entry, which is every bit of the annual while comparing two different
based on management report and not just the companies.
estimates (ex: revaluation of
financial statements
the fair value). Therefore, Conclusion
investors must focus on the before investing. Figuring out the amount of
core operating revenue money a company is earning
because earning other income is not only is more complicated than it sounds. Therefore,
unsustainable but also not the fundamental investors need to rigorously examine every bit
purpose of running the company. of the annual report and not just the financial
Takeaway: Investors should pay more statements before investing. Investors can
attention to operating income and should not access the P&L of every listed company on
get carried away by increases in other income. www.valueresearchonline.com. All they need
to do is type the name of the company in the
Principle 3: Revenue recognition search bar and they can access the company’s
varies from industry to industry page, which has the P&L under the ‘Financials’
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tab. The P&L of Reliance Industries can be

found here and a screenshot of the same is
given below.
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Understanding Expenses
Expense items of the P&L statement shed light on the costs
incurred by a company to generate revenues
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e have already gained insights into selling and distribution expenses, etc. The following
the basics of the P&L statement and is a screenshot of different types of expenses of
the income part of it. Next, we will Maruti Suzuki, India’s largest car manufacturer.
focus on ‘expenses,’ which is more important than A higher amount of disclosure with regard to
the income part. expense items is very beneficial for investors
Like income items, expense items also follow because it enables them to keep track of a
accrual-based accounting principles. But expenses company’s expenses over a period of time and
are more complicated. Here are a few important compare different companies based on how
aspects of expenses: efficiently they are running their operations.
Greater disclosure Greater management discretion

Unlike income items which are divided into two Unlike income items which are divided into two
parts, expenses are divided into multiple heads, parts, expenses are divided into multiple heads,
such as raw-material expenses, employee expenses, such as raw-material expenses, employee
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expenses, selling and distribution expenses, etc. accounting, an organisation needs to only
The following is a screenshot of different types expense those items from which it will derive
of expenses of Maruti Suzuki, India’s largest car benefits in the current year. Think about rent or
manufacturer. electricity expenses for a particular year. The
benefits of this expenditure can be enjoyed only
for a small period. But if the company purchases
an asset, which will last for many years (such as
a car or a manufacturing plant), then it would
not be fair to charge the entire expenditure only
in the first year. The correct thing to do would
be to consider only the portion of the capital
asset that has been used in the current year as
expenses, a method known as depreciation.
Besides, accounting standards require the
management’s inputs for various decisions.
Investors need to analyse

the expenses segment
with a fine-toothed comb
before making any
investment decision
Therefore, the management can exercise

significant control over expenses. For example,
A higher amount of disclosure with regard to while calculating depreciation, a company’s
expense items is very beneficial for investors management decides important factors, such as
because it enables them to keep track of a the expected useful life of the equipment, the
company’s expenses over a period of time and choice of the depreciation method and the
compare different companies based on how expected salvage value. Similarly, there are
efficiently they are running their operations. other areas where the management’s inputs are
integral to the accounting process. Although
Greater management discretion such inputs are believed to make the books of
Unlike income items, recognising expense items accounts more pertinent, there is always a
under the accrual-based accounting systems possibility of unscrupulous managements
depends substantially on the management’s misusing this discretion to manipulate earnings.
discretion. For example, the decision to either
capitalise or expense a particular expenditure One-time expenses
rests on a company’s management. This Even though accrual accounting requires the
distinction arises because under accrual-based management to account for all the expenses
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associated with a particular accounting of expenses are recorded as expenses,

period, sometimes certain expenses are not investors need to differentiate between them.
mentioned. These expenses could be in the While the former can be attributable to
nature of write-downs to goodwill (an aggressive management practices, the latter is
accounting term that refers to the difference more likely than not attributable to the
between the market value and book value of business’s core nature.
an asset), the unfavourable outcome of tax
litigation, etc. Also, there are other scenarios Key takeaways
where sudden unforeseeable events happen, The expenses segment is a very significant
forcing the management to take a hit. For part of the P&L statement. Investors need to
example, a sudden drop in the prices of oil or analyse this segment with a fine-toothed comb
gold could lead to a write-down in inventory before making any investment decision. The
for oil-marketing companies and gold P&Ls of all listed companies are accessible on
jewellers. Even though both these categories www.valueresearchonline.com for free.
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Understanding Tax
and Other Items
How tax, minority interest and share of associates impact
a company’s bottom line
A
fter learning about the basics of the
Tax expense
P&L statement and the income and
The Government of India levies income tax on
expenses part of it, readers may now
the profit earned by every company. Therefore,
think that all they need to do now is subtract
when you subtract all expenses from the income,
expenses from the income in order to compute
the figure you get is the profit before tax or PBT.
the profit or loss. While this is almost true, some
Tax expenses are calculated based on the PBT
more steps are required to calculate the real
and recorded in the P&L statement as the
profit/loss of a business.
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provision for tax. The real profit is what you get Tax expenses are
after the tax is deducted from the PBT. This
figure is known as the profit after tax or PAT.
calculated based on the
PBT and recorded in the
P&L statement as the
provision for tax.
subsidiaries and therefore, needs to prepare a
single P & L, comprising the income and expenses
of all its subsidiaries. According to accounting
principles, the consolidated figure is calculated
simply by adding all income and expenses. Let’s
look at a simplified version of the consolidated
P&L of a hypothetical company (ABC Ltd),
which has just one subsidiary (XYZ Ltd).
As stated in the above-mentioned table, the

consolidated P&L is calculated by just taking the
simple sum of the parent and subsidiary
Investors must bear in mind that the provision
companies. However, when it comes to
for tax may not necessarily be the tax rate
calculating this type of consolidated P&L, it is
multiplied by the PBT. This is because there are
always presumed that the parent company
many allowances and deductions from an
owns 100 per cent of the subsidiary company.
income-tax point of view. Therefore, the
Now a problem arises with this method when
amount of PBT is different and the tax payable
the parent company owns anything less than
varies too. Since this is an area where the
that. For example, if the parent company owns
management’s inputs are required, investors
only 75 per cent of the subsidiary company in
should remember that the PAT declared in the
our above-mentioned consolidated table, then
P&L statement is also, to some extent, only an
the parent company is entitled to only Rs 30,
estimate and not the final figure.
i.e., 75 per cent of Rs 40. Therefore, there
would have to be an adjusting entry to decrease
Minority interest the profits by Rs 10 and this is precisely what the
Minority is another important aspect that
term ‘minority interest’ refers to.
investors should consider. However, this part
So, investors must always look at PAT after
comes only in a consolidated P&L (as opposed
adjusting for the minority interest.
to a standalone P & L) where a company has
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accounting principles do not require the

company to create a consolidated P&L. Instead,
the company can recognise a proportional
share in its investee company’s profits. It could
be said that this entry is, in a way, the corollary
of minority interest. For example, in the previous
illustration, if ABC Ltd is the minority shareholder,
holding 25 per cent in the subsidiary company
(XYZ Ltd), then it would recognise a profit of Rs
10 in the P&L statement as its ‘share of associate’.
Figuring out the amount

of money a company
is earning is more
complicated than it
sounds. Therefore,
investors need to
rigorously examine
every bit of the annual
Again, investors would do well to recognise
report and not just the that the net income as adjusted for its share of
financial statements associate gives a more accurate picture of the
before investing. company’s overall profitability.
Earnings per share

Share of associates After making the above-mentioned adjustments,
When a company has subsidiaries in which it the final number is the consolidated PAT. This is
has less than 50 per cent shareholding, then the total amount of profit that is available to all
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shareholders. Although it is the primary factor

that investors should take into consideration, it
is equally important to consider earnings per
share or EPS. It is calculated by dividing the
total PAT by the total number of shares
outstanding and is given on the website of Value
Research under the head ‘Adjusted EPS’.
While there is generally a perfect correlation
between the consolidated PAT and the EPS,
there are certain circumstances when these two
numbers diverge. These happen when there is
a significant change to the capital base of the
company. A case in point is YES Bank Ltd. After
a spell of poor performance, new shareholders
infused a large chunk of capital at very nominal
prices, thereby causing massive dilution for
existing shareholders. This has led to a situation
where even if the consolidated PAT of Yes Bank
returns to its pre-stressed levels, the EPS will
remain extremely depressed.
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Conclusion
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ith the P&L being issues, etc. Likewise, when investors
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n n n n n n n n n an important financial are aware of complications related to

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statement, this ebook will accrual accounting, they can identify
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true picture of a company’s financial financials. And finally, getting a better
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n n n n n n n n n affairs but also become a better understanding of different types of

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investor. For example, the concept of one-time expenses will enable
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n n n n n n n n n the superiority of earnings per share investors to assess a company’s

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over net income would assist investors accounting policies more effectively.
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n n n n n n n n n in evaluating the impacts of mergers, We hope you have enjoyed reading

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acquisitions and other corporate this ebook and we wish you the best
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n n n n n n n n n activities such as buybacks, rights in your investment journey.

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n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n n

HOW TO READ THE

n n n n n n n n n HOW TO READ THE P&L STATEMENT

Understanding Tax and Other Items

discoms) are particularly affected by this. When it comes to recognising long-term

tab. The P&L of Reliance Industries can be

Greater disclosure Greater management discretion

Investors need to analyse

Therefore, the management can exercise

associated with a particular accounting of expenses are recorded as expenses,

As stated in the above-mentioned table, the

accounting principles do not require the

Figuring out the amount

Earnings per share

shareholders. Although it is the primary factor

n n n n n n n n n HOW TO READ THE P&L STATEMENT

n n n n n n n n n an important financial are aware of complications related to

n n n n n n n n n not only help investors understand the companies with deteriorating

n n n n n n n n n affairs but also become a better understanding of different types of

n n n n n n n n n the superiority of earnings per share investors to assess a company’s

n n n n n n n n n in evaluating the impacts of mergers, We hope you have enjoyed reading

n n n n n n n n n activities such as buybacks, rights in your investment journey.

HOW TO READ THE P&L STATEMENT

To read more such

insightful articles, visit

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