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. The ratios investors look at most often, such as the PE and yield, are calculated using numbers from the P & L.

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

The P & L can be 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, the cash flow statement (which is harder to manipulate) and the other accounting statements.

The shortest possible P & L would be: sales less costs = total profit.

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.

The profit and loss account is structured to provide a reasonably concise breakdown 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. Not always synonymous with turnover. Revenue recognition is not always simple.
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
Profit after tax Pre tax profit less tax
Retained profit Profit after tax less dividends
Earnings per share  

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 secondary or dual listing in a country that requires quarterly announcements.

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 P & L 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 backward looking and investors will need to consider correcting some items such as amortisation that are not useful for modelling 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.