What is a Profit and Loss Statement (P&L)?
Every company produces three important financial reporting documents when the fiscal period comes to a close: the balance sheet, cash flow statement, and the profit and loss statement. Among these, the profit and loss (P&L) statement is perhaps the most illuminating in terms of operational efficiency. It’s a financial statement summarizing revenues, costs and expenses incurred during a given period, such as the fiscal year.
At face value, a P&L statement shows the company’s ability (or inability) to generate profit. It breaks down the income and expenses of the company during the period, and shows how efficiently the company uses its cash. No matter the size or complexity of the company, the profit and loss statement is a direct window into operations from a financial standpoint. Here’s what investors need to know.
Multiple Names for the Same Information
Profit and loss statements go by many names. This can be confusing for new investors looking for sales and revenue data, operating costs and profit information. Companies may call their P&L statement any of the following:
- Statement of operations
- Statement of financial results
- Earnings statement
- Expense statement
- Income statement
The reason for all these names? They’re all explanations of the information you’ll find on one. The best way to ensure you’re looking at the right document is to look for operating figures and profit data. Often, P&L statements come packaged with the company’s balance sheet and cash flow statement, for context.
To make things even more confusing, a P&L for nonprofit organizations is often called a statement of activities.
Types of P&L Statements
While a P&L statement will always summarize the revenues, costs and expenses of the company, it may do so differently depending on the accounting method used. Smaller companies tend to use cash basis accounting, while public companies use accrual.
- Accrual-based statements. Accrual basis accounting realizes transactions at the point of origination. This means that accrual P&L statements also include future revenues that are already earned but not realized. The same goes for liabilities.
- Cash-based statements. Cash basis accounting records transactions only when money changes hands. A cash accounting P&L statement will only reflect revenues and expenses that have already transacted.
While cash-based P&L statements are simpler to review and digest, accrual-based statements are more accurate and representative of a company’s financial position.
What’s Listed on a Profit and Loss Statement?
The P&L statement breaks down revenues, costs and expenses into individual line items based on how they’re incurred over the reported period. Here’s a look at the chief categories broken out on an income statement:
- Revenue (or Sales)
- Cost of Goods Sold (or Cost of Sales)
- Selling, General and Administrative (SG&A) Expenses
- Marketing and Advertising
- Technology/Research & Development
- Interest Expense
- Net Income
Larger, more complex companies will invariably have more complex statements to account for diverse financial activity. Smaller companies will similarly have simpler statements, with fewer types of profit and loss data to report.
What Does the Profit and Loss Statement Tell Investors?
Investors looking for information about a company’s profits will find it on the P&L statement. How profitable is the company? How are those profits generated? What expenses stand in the way of higher profitability? The P&L statement contains this information and more. Some of the key line items displayed include:
- Gross profit margin
- Operating profit margin
- Net profit margin
- Operating ratio
The profit and loss statement also paints a picture of general financial health for the business over time. P&L statements compared over different periods will tell the tale of a company’s ability (or inability) to grow by increasing sales, decreasing expenses and managing costs.
All public companies are required to produce a P&L statement and file it with the Securities and Exchange Commission (SEC). Moreover, like all formal financial statements, P&L statements must comply with GAAP reporting standards and stand up to rigorous auditing by a third party.
P&L Statement vs. Balance Sheet
A profit and loss statement shows the company’s income, expenditures and profitability for the period. The balance sheet shows current assets and liabilities at the time it’s issued. Investors use the balance sheet as a gauge of the company’s intrinsic value and financial strength. Meanwhile, the P&L statement tells the tale of efficiency and trajectory as it relates to operations. Both are important documents in their own right.
P&L Statement vs. Cash Flow Statement
Cash flow statements measure the sources and uses of cash coming into and flowing out of a business over a reporting period. Meanwhile, the P&L statement shows the company’s performance over that time frame. The cash flow statement provides context for the P&L statement by showing that the company can remain solvent throughout the course of everyday operations. Both statements offer useful insight into a company’s financial operations, and are especially useful when juxtaposed together.
A Measure of Operating Efficiency Over Time
Comparing profit and loss (P&L) statements over consecutive periods or from previous periods paints a picture of how the company is able to manage growth. Have revenues increased? Have expenses gone up? What’s the proportion of growth between these figures?
And these figures can go a long way in helping investors determine if a company is a good investment or not. To learn how you can build wealth through the stock market, sign up for the Liberty Through Wealth e-letter below.
Generally, companies that can grow revenue while minimizing expenses will find themselves more attractive to investors. Conversely, companies that aren’t growing will show stagnation. Investors need to take insights from the profit and loss statement—as well as the balance sheet and cash flow statement—and use them to inform decision-making. Look for companies that know how to grow revenues, manage expenses and operate with efficiency from period to period.