Profit and loss

Profit and loss main line items

Profit and loss main line items are detailed briefly below.

Profit & loss

Revenue

The value of what we have sold to our customers.  Equals turnover equals sales.

Cost of sales

Our direct costs of production.

Gross profit

The difference between the two line items above.  If expressed as a %, also known as gross margin.

Admin costs, excluding depreciation and amortisation

Central business costs not allocated to the costs of producing goods or services.  For example, central head office costs, legal, human resources, property costs.

EBITDA

Equals gross profit less admin costs, excluding depreciation and amortisation.

EBIT = operating profit

Earnings before interest and tax (also known as operating profit), equals gross profit less all admin costs.

Interest

Equals the business’s costs of finance e.g. interest costs charged on bank loans.

PBT

Equals profit before tax minus interest.

Tax

Corporation tax charged by tax authorities.

NPAT

Equals net profit after tax (also known as “net profit”, “net income” or “the bottom line”), equals PBT less tax.

Dividends

Equals distributions to shareholders.

Retained earnings

Equals NPAT less dividends.

How might this affect me?

Depending on what business you’re in, and what your job is, here are a few ways in which some of the above could impact you.

Financial accounts: issues in the profit & loss statement

P&L items are a focus for performance measurement and comparison

EBITDA is often used to measure financial performance, or used in valuation multiples to price businesses (a buyer pays a multiple of EBITDA).  EBITDA is favoured because it provides a measure of a business’ ability to generate cash.  It also helps make comparisons between businesses.  Different countries can have different levels of debt, can be doing business in different countries, and can have different asset mixes or acquisition histories.  All this means that interest, tax, depreciation and amortisation costs can vary between businesses.  By adding back I, T, D & A, it’s easier to compare businesses and judge which are performing better.

P&L items and company sales

If you ever participate in a company sale, profits and EBITDA may be closely reviewed and tracked as you go through the sale process.  Further more, if the business is sold in an “earn out” (where the buyer pays more for the business as time progresses and the company hits certain profit targets) then the earn out is going to be linked to key P&L measures.  A seller of a business would like an earn out linked to a profit measure as high up the P&L as possible, removing any scope for manipulation (e.g. should the buyer introduce new management charges or central costs into administration costs).

Cash is king

When measuring business performance, or comparing businesses, analysts are often concerned about cash flow impacts.

For example, a company whose customers are paying slowly, or needs to invest heavily in fixed assets, is going to suffer a cash flow drain.  That business is going to compare poorly against a company that can get its customers to pay more quickly, or already has new assets.

If you found yourself involved in a company sale or acquisition, a buyer is going to be worried about the cash flow impact of what they are seeing in the accounts.  A buyer might require an adjustment to valuation to compensate for the cash required to fund the delay in customers paying, or the investment required in fixed assets.

Proceed with the finance for non-financial managers training course

The finance for non-financial managers training course proceeds on to explain the depreciation and amortisation line items on the profit and loss statement.