How to read a profit and loss statement

A crucial step to business success or failure

The Profit and Loss statement, also called account, or the Income statement, is a document prepared by almost all business entities — sole traders, partnerships, private and public limited companies (PLCs). Whereas the first three do so for tax purposes, PLCs are required by financial authorities to disclose the valuable information in return for being listed on stock exchanges (hence why they are called public). We will go from top to bottom of a level-1 P&L and account for slight variations for the different types of companies.


Step 1

Understanding the P&L statement

The P&L statement provides a business owner with an overview of how their business is performing. It consists of revenue/sales, cost of goods, gross profit, expenses, and the net profit or loss of the business. Like with an equation, you start with Revenues (the money taken from customers) and deduct all the expenses you have incurred (the money you have given to others). What’s left is your profit (the money you have made for yourself). Typical expenses include: Wages, Rates and rents, Interest, Depreciation, Loss/Profit on sale of equipment, Wages, Insurance, etc.

Step 2

Understanding revenue

Revenue is how much the firm has sold in the case of a plant or retail shop or how much of a particular service has been provided. Some smaller enterprises write the number of sold units and their selling price. The numbers usually bear no meaning when taken out of context so use the figures from previous years to compare whether the entity has been able to expand. DO distinguish between real growth where sales increase and nominal growth which arises from inflation. Most financial statements come with notes so check those elaborating on the P&L if, for example, there is a sharp change in sales figures — a political or economic event may explain it.

Things Needed
• Calculator
• The statement to be analyzed

Tips & Warnings
• There is more than meets the eye.


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