How to read a Profit and loss statement.

How to read a Profit and loss statement

As you know to become a good investor one must be good at reading the fundamentals of a company which you will mostly get in the annual report. And the most important part of the annual report is the financial statements so today we are going to discuss the profit and loss statement of a company.

The profit and loss statement is also known as the P&L statement, Income Statement, Statement of operation and Statement of earning. The profit and loss statement shows what has happened during a period.

The P&L statement contains:

1. Revenue of the company for a given period (yearly or quarterly).
2. The expenses of the company.
3. Tax and depreciation.
4. The earnings per share number.

You will better understand by looking at the actual Profit and loss statement of Maruti Suzuki.

Profit and loss statement

                                  

Now, let's understand each line of the profit and loss statement.

Note: All the currencies here are in Million Rupees, 1 Million Rupees = 10 Lakhs Rupees(₹ 10,00,000) .

Revenue also know as the Top line of the company.

Here if you look at the Particulars of the expense side of the company, the first line tells that the Revenue from operations for the financial Year was ₹860,203 million whereas in the previous year it was ₹819,994 million. 

Total Income (Revenue)

The company also included revenue generated from Other income sources which were ₹21,610 million for the FY2019 and ₹20,445 for the FY 2018.

Now, finally, if we sum up both Revenue from operations and other income we get the total revenue generated which is ₹885,813 for the FY2019 and ₹840,399 for the FY2018.

So, if you want to know the details i.e. from the does the company generated the revenue, you must refer to the notes.

Here is the detailed review of the Revenue from operations of the company refer to note no:22    

Revenue from operations (notes)

                                         

                   

• As you see under the particulars, Sale of products tells you that it generated ₹747,215 million for the FY2019 versus ₹731,314 million for the FY2018 only by selling vehicles, so, we can conclude that the sales of vehicles have decreased.
• The sales of other products such as Spare parts/dies and moulds/components generated, ₹82,550 million for the FY2019 and ₹72,051 for the FY2018. So, now if you look at the total sales of the product, it had decreased on the year on year basis.
• Next comes Other operating revenues. Here you will find all the sources such as Income from services, Sale of scrap, Rental income and others. If you sum them, it will be ₹860,203 million for FY2019 and ₹816,994 for FY2018 it has also had a gradual increased.                                    

As we can see that other income is not related to operating revenue and are income generated otherly than the main business of the company. It includes interest income on Bank deposits, Income tax refund, Receivables from dealers, etc. Usually, it should form a small part of the total income. A large other income generally draws a red flag and would demand a further investigation.

Expenses.

Now, moving to the next part of the P&L statement which is the expense details i.e the cost that a company has to bear to run itself. Here is a snapshot of the expenses in a P&L statement.

Expenses

                         

The first item on the expense side is 'Cost of materials consumed' which is the total cost that the company has spent to buy raw materials to manufacture finished products. So, here ₹346,366 million required in FY2019 whereas ₹450,239 million in FY2018 were required to buy raw materials. As you can see a large proportion of the total amount has gone to buy raw materials, you can refer to the notes to know in detail. so from here, you assume that this might be one of the reasons the revenue decreased in the FY2019 to FY2018 (the Cost of materials consumed was less hence it could have fewer sales and hence the Revenue from operations decreased).

Material Consumed (notes)

The next two items on the expense talk about Purchases of stock-in-trade and changes in inventories of finished good reference to the notes to know in detail. Here Purchases of stock-in-trade refers to all that item that the company has to buy to run its business and  Changes in inventories of finished goods refers to the cost of manufacturing that the company had in past, but the goods manufactured in past were sold in the current financial year.

If a change in inventories of the finished good is negative, it means the company has produced more goods in the current financial year, to give a sense in terms of sales and cost of sales the company deducts the cost of the current manufacturing items (which are extra) from the current year cost. The company will add this cost when they manage to sell these extra products in future. This cost which the company adds back later will be included in the 'purchase of stock-in-trade's items.

Here is a snapshot of the same for your better understanding:

Expenses (notes)

 

The next item in the expense side is the Employee benefits expenses. This item refers to the expense which includes salaries paid, company's contribution towards provident fund and other employee expense. Here for FY2019, it stood at ₹32,549 million Now, have a look at its notes to know more:

Employee Benefits (note)

                 

The next line tells you about the Finance costs/Financial charges or Borrowing costs. It is the interest or other costs that the company has to pay whenever it borrows funds. Now, following with Depreciation and Amortisation expenses which stands at ₹35,257 million for the FY2019, to understand this we have to understand tangible and intangible assets.

A tangible asset is a type of asset which has a physical form and provides economic value to the company. For example buildings, machines, computers, vehicles, etc. Whereas an intangible asset is a type of asset which doesn't have any physical form but still provides economic value to the company. For example Licenses, Patents, Copyrights, Trademarks, etc.

Now any asset tangible or intangible both will be depreciating over the coming years, for example, if you buy a computer, its useful life will be 5 years. 

Now let's understand how depreciation works in any business. Assume that Maruti Suzuki has a factory and will be needing machinery to manufacture cars and it purchased machines for ₹10 million and the useful life of the machine would be 10 years. So, as the machine bought this year will serve the company for the next 10 years, hence it would make sense to spread the cost according to its life expectancy since it would provide economic value up to 10 years. Thus ₹10 million would be spread across 10 years as expense i.e. ₹10,00,000/ 10= ₹1,00,000. So, it would depreciate ₹100K every year over the next 10 years as an expense and this is called depreciation. Now, If you do the same thing for intangible assets then it is called Amortisation.

Here is a snapshot of the same.

Finance costs/Financial charges or Borrowing costs

                

The next line in the expense side is the other expenses and it is ₹116,340 million for the FY2019 and it's a huge amount so for detailed review refer to the notes.

Here is a snapshot:       

Other expenses(notes)

So, now adding up the Expenses of Maruti Suzuki, it spent ₹ 781,157 million for the FY2019.

Profit Before Tax.

The next part of a Profit and loss statement is the Profit before tax. It refers to the net operating income after deducting operating expenses but before deducting taxes and interests.

So Profit before tax (PBT) = Total Revenue -Total operating expenses

                                           = ₹789,944 - ₹720,100

                                           = ₹69,844.00

Net Profit after Tax.

The last part of a profit and loss statement is the Profit for the year/ Net profit after tax. It is defined as the company's operating profit after deducting the tax and here is the snapshot of the same also called the bottom line of profit and loss statement.

Net Profit after tax

    

Here, you can see how it's calculated :

Profit after tax (PAT) = PBT - Tax Expenses (Current tax+Deferred tax)

                                   

Now, if you want to see the Tax Expenses in details refer to the notes also and also show below

Tax expenses (notes)

                  

And the last item in the P&L statement talks about Basic and diluted earnings per equity share and it is the most frequently used statistics in a financial statement. It shows how much the company is earning per face value of the ordinary share. To know in detail about EPS refer to the notes.

Earning per share(notes)

         

It is calculated by the total number of outstanding shared divided by PAT. So, here 302,080,060 numbers of outstanding shares are available in the market and ₹76,506 is the PAT. So, the EPS will be ₹ 253.26 for the FY2019.

So, as we know that P&L statement is one of the most important financial statement and is closely connected with two other financial statements i.e. Cash flow statement and the Balance sheet every investor should go through it carefully. And remember that all the item in the P&L statement will have associated notes, do look to know the items in details and to become good independent investors. 

~By Suddha.