Profit and loss account
The profit and loss account (P & L)), called the income statement in the US, shows the profit or loss a company has made over a period of time. It is the most looked at accounting statement. The ratios investors look at most often, such as the PE and yield, are calculated using numbers from the P & L.
Investors should not make the common mistake of thinking that the P & L is all they need to look at. This is not only because the P & L can be manipulated to mislead investors, but also simply because it is important to have a full picture.
The most detailed profit and loss account is given in the annual report, but UK listed companies are required to make annual and half year results announcements as well. The full year results announcement is shorter and covers the same period as the annual report, but it is released earlier.
Many companies make quarterly announcements, as companies in the US and many other countries are required to. Unsurprisingly, UK listed companies that also have a US listing are very likely to report quarterly.
The shortest possible P & L would be: sales less costs = total profit.
In a simple case the profit or loss equals the increase or decrease in the company's assets as shown on the balance sheet. This is rarely exactly true and the statement of total recognised gains and losses reconciles the P &L to the changes in equity shown on the balance sheet
In accordance with the accrual principle, costs and revenues are matched so that, for example, sales and purchases made on credit during a year, but perhaps not yet paid for, will be included in the P & L for the year.
Most of the detail in the profit and loss account comes from the need to provide detail of costs and, to a lesser extent, revenues. This leads to the general form of a P & L that looks something like this:
| Sales | Also called revenues or turnover |
| Cost of sales | The direct costs of things sold |
| Gross profit | Sales minus cost of sales |
| Other operating expenses | Depreciation, admin, marketing etc. |
| Operating profit | Gross profit less other expenses |
| Interest costs | Interest payable less receivable |
| Pre-tax profit | Operating profit less interest |
| Tax | |
| Profit after tax | Pre tax profit less tax |
| Dividends | |
| Retained profit | Profit after tax less dividends |
| Earnings per share | |
As can be seen, the P & L contains several profit numbers. Each of these gives us different, and useful, information. In addition, the P & L (perhaps together with other information) usually gives us enough information to calculate several other profit numbers such as EBITDA and EBITA
Many companies will show exceptionals separately. If there were any discontinued business, or plans to dispose of a business within a short period, these are also shown separately.
These can give investors a better idea of the underlying business (the justification for doing it). For example, if the company has decided to sell a particular operation and the price has been agreed, shareholders do not really need to worry too much about that operation's performance.
A group balance sheet will need to be consolidated, which requires extra lines such as those for share or profit in associates and joint ventures, and the deduction of minority interests.
As well as the valuation ratios, the P & L provides the numbers for measures of the performance and efficiency of the business, such as margins, ROCE, and some measures of financial stability such as interest cover.
The P & L is potential misleading and there are a number of accounting techniques that can shift losses (or gains, although that is rarer) from the P & L to the balance sheet. The P & L should be looked at in conjunction with the notes and the cash flow statement (which is harder to manipulate).
The P & L is backward looking and investors will need to consider correcting some items such as amortisation that are not useful for modeling future cash flows. From an investor's point of view the P & L is essential, but can be misleading and should not be looked at in isolation.