What is a profit and loss statement (P&L)?
A profit and loss statement, or “P&L,” is a financial report that shows a company’s income and expenses for a certain period, which is usually a three-month quarter or a full fiscal year. A P&L is also called an “Income Statement” or “Income and Expense Statement.”
A P&L statement provides a clear breakdown of exactly how much money a company is earning, how much it’s spending, and how those two numbers compare. It shows how much the company earns from sales and investments as well as what it spends on overhead, raw materials needed to produce goods for sale, and other expenses.
The items included on a P&L statement can vary from company to company. Below are the basic types of profit and loss, with some examples that you might find on the P&L of a fictional car dealership:
- Revenue from primary activities
- For a car dealership, the primary activity is the sale of cars.
- Revenue from secondary activities
- For a car dealership, a secondary activity might be providing financing to customers, which brings in interest income.
- This can also include such things as rental income if the company rents out space or equipment to someone else.
- Other Income or Gains
- Selling an investment at a profit.
- Dividends or interest earned from, e.g., stocks, mutual funds, and loans.
- Gain on the sale of an asset, such as equipment, auto-servicing tools, or the wacky-inflatable-arm-flailing tube man.
- Expenses from primary activities
- Cost of goods sold, or “COGS,” such as the cost of buying cars from the manufacturer to sell to consumers and the cost of salaries and commissions for salespeople.
- Overhead costs, such as rent, insurance premiums, taxes, advertising, research, and development, and wages for administrative personnel. Also called “operating expenses” or “OPEX.”
- Expenses from secondary activities
- The interest paid on the mortgage for the dealership building.
- Money lost in a lawsuit filed by a customer who was sold a car with no brakes.
- Other losses
- Selling an investment at a loss.
- Loss on the sale of an asset, such as selling the inflatable tube man for less than was paid.
- Depreciation on items that lose value over time, such as in-use vehicles, equipment, and property.
The bottom line
The phrase “the bottom line” actually comes from the P&L statement. On this document, the first item or “top line” is revenue, which reflects the amount of money the company earns from sales.
All other income and expenses are listed below revenue on the P&L. At the bottom of the statement is “net income,” which represents the total amount of revenue left over as profit after accounting for costs and expenses. Net income is called “the bottom line” because it is literally the last line on a profit and loss statement.
Why is it important?
Companies produce four important financial documents each quarter and at the end of the year—a P&L, a balance sheet, a statement of retained earnings, and a cash flow statement. Together, these documents are used to assess the financial health of the business, to pinpoint areas of weakness or unnecessary spending, and to inform decisions about operational changes aimed at improving the bottom line.
All four documents are important for two groups of people: company management and investors.
Financial Documents for Management and Investors
|Helps find the specific source of operational inefficiency. Clearly breaks down all the different expenses.||Used to assess the health of a company. If the finances don’t look good, buying stock isn’t a great idea.|
|If the company is losing money compared with the previous period, the P&L sheet shows if it’s because revenue is down or costs are too high.||Along with other sources, financial statements are used to assess the skill of a company’s management.|
|If costs are high, the P&L shows exactly which expenses need to be reduced.||If financial reports don’t show improvement or stability over time, it can mean that management is failing to sufficiently deal with problems, which is bad for future growth.|
|Statements from different periods can be compared to gauge the effectiveness of implemented changes.||Provides information needed to calculate important metrics, such as “Earnings Per Share” or “EPS” that are used to estimate the true value of stock.|
|Statements provide clear goals for improvement of specific figures (e.g., cost of materials needs to be reduced, sales need a boost, overhead is too high).||Revenue, net income, and other key figures are compared with analysts’ projections every quarter when companies release their “earnings reports” for shareholders.|
|Helps management know which questions to ask. If revenue is down, for example, why? Is consumer interest falling? Is a competitor taking up market share? The P&L shows management where the company needs to improve.||If a company exceeds expectations, the stock price will likely go up. If the company misses the mark, the stock may lose value.|
|Clear numerical data helps management communicate the company’s status with shareholders and the public.||Investors can use earnings-based swings in stock price (see above) to strategically buy and sell shares for both short- and long-term profit|
- A profit and loss statement, or P&L, is a financial report issued each quarter and at the end of the year showing how much money a business earned and spent during the period.
- The P&L, or Income Statement, starts with the company’s revenue for the period, called the “top line,” and ends with its net income, called the “bottom line.”
- In between, it shows how much money was earned from primary and secondary activities and how much was spent on such things as raw materials, overhead costs, and debt payments.
- It is used by both investors (stockholders) and upper management to gauge the efficiency, profitability, and financial stability of the company.
- When video game development company Zynga released its financial statements for the second quarter of 2012, it missed analyst estimates, and its stock price fell nearly 40% overnight.
- When Google beat revenue and earnings estimates in the second quarter of 2015, the stock jumped $93.08 per share within 24 hours, the largest post-earnings spike in history at the time.