KR editions 143 to 146
KR-143 : P & L
Hi everyone,
Moving on with financial statements...
The next statement is the income statement; also called profit and loss (P&L) statement or the statement of income and expenses or operating statement.
The names actually reveal a good deal about what this statement contains.
Some things we find on this statement are:
Net Sales - if it is a service providing company they would usually term this row as "revenues". This basically accounts for the amount of revenue the company has made in its line of business (i.e. whatever the company earns doing its primary business - for instance if a toys manufacturer is going to sell some piece of land, then this won't be accounted under the category revenue; why? Because their primary business is earning revenue by selling toys and selling a piece of land is just an occasional transaction).
To produce or manufacture or even provide service there are some costs that have to be incurred during the process. Simplest cost incurred is the cost to pay for labor. That brings us to the next row in our income statement:
Cost of sales (also called cost of revenue): This denotes the amount of money that had to be spent for earning the revenue. Employee salaries, cost of delivering the product, paying commissions to the salesperson, installation are all clubbed together in this category.
Now we know how much a company earned and how much they had to spend to earn that much. The difference of the two is what is called "GROSS PROFIT".
GROSS PROFIT = SALES - COST OF SALES
This is one parameter everyone in the company would look at; it tells us how much of profit the company is able to make by selling its products (or providing services). Obviously gross profit needs to be positive otherwise the company is heading downwards (a negative value is something like "a toy company selling a toy for $10 but for which it actually spends $12 to make!" - a gross profit of -$2!).
KR-144 : More P&L
Continuing with the income statement (P&L statement)...
We saw "gross profits" in the previous edition; it is an important parameter to keep track of; the gross profit might change the following year if the company is forced to reduce its sale price of products (maybe because of competition in the market or because demand is less etc).
Next component in income statements is the General Operating Expenses: This comprises general expenses which aren't tied to a specific product. For example trying to promote the brand image of a company will be a marketing expense which can't be categorized under "cost of goods sold". Some divisions under this category might be: General and Administrative expenses Marketing expenses
Next comes the D&A component (depreciation and amortization): Both are pretty similar and so we'll look at depreciation (we've already touched upon this in an earlier KR)- when an equipment is purchased by a company it is usable over a certain period of time. For instance if a company buys a lathe for $1000 then this $1000 expense should be spread over the lifetime of the lathe rather than being accounted as an expense only during the year it was purchased in. If a lathe has a lifetime of 10 years, then the company will depreciate this $1000 over 10 years and thus the company will say "we had a $100 expense this year" for the next 10 years.
Those are the general operating expenses and now we can derive the next equation:
OPERATING INCOME = GROSS PROFIT - ( GENERAL OPERATING EXPENSES + DEPRECIATION )
This is self-explanatory and denotes the income the company is able to generate after including all operating expenses (like salaries, advertising, marketing expenses, miscellaneous expenses like commissions, rents etc).
We'll wind up this edition with an interesting acronym: EBIT (hE BIT who?)
Formula: EBIT = EBITDA - DA :-)
KR-145 : Debt=Equity?
We'll take a look at hE BIT who, EBIT, in the next edition...before that it's important to understand what debt and equity mean in in the world of finance.
The terms debt and equity are frequently used in finance.
In general both refer to ways in which a corporation can finance its activities (i.e. ways in which a company can obtain funds). But both are slightly different.
Debt is like taking a loan - the borrower has to repay the lender at some point of time in the future.
The borrower is called the debtor and the lender is called the creditor (creditor is another term frequently used in finance).
When we take a loan from the bank, the bank is the creditor and we are the debtor.
Equity refers to the money obtained by selling stocks. In this case the company needn't pay back the person who bought the stock.
If a debt is not paid back then it is a liability for the company. The creditors can take legal action against the company and even take over the assets owned by the company. But in the case of equity this possibility doesn't arise. Stockholders can't claim back the money they spent on purchasing stocks.
Generally stockholders will have voting rights but creditors will not. Creditors won't have any say on the selection of the management team or the running of the company. But stockholders are owners of the company.
A creditor can only get back the money lent and the interest but a stockholder might get much more than what was spent in buying the stock (dividends + capital gain as we discussed earlier).
Did you know that the founder of Apple computers, Steve Jobs, was fired from CEO position and later reappointed as CEO when the company was on a decline? (currently he is the CEO).
KR-146 : hE BIT who?
We're back to EBITDA.....
It stands for EARNINGS BEFORE INTEREST, TAXES, DEPRECATION and AMORTIZATION.
And EBIT stands for EARNINGS BEFORE INTEREST and TAXES.
That's why we can say: EBITDA = EBIT - DA or EBITDA + DA = EBIT !
Confusing? It's simple; EBIT includes DA while EBITDA doesn't. So if we subtract the DA part from EBIT we'll end up with EBITDA!
Anyway, it's more important to understand what this figure actually represents; EBITDA represents the company earnings (cost of revenue - cost of sales - other expenses) before we deduct taxes, interest and deprecation figures.
Taxes: Just as we individual pay taxes, corporates also have to pay taxes (the rates for corporates will differ from those of individuals).
Interest: We saw in our earlier edition that companies can use debt to finance their operations (debt like loans); When we take a loan from a bank (or a lender), we have to pay back the principal amount as well as the interest accrued.
Deprecation: covered in an earlier edition.
The idea behind EBITDA is to figure out how well a company is doing without considering the ITDA components (i.e. how much revenue can the company generate). Why exclude them? Companies that are in the initial developing stage have to spend a lot of money to buy equipment (contributes to the D part) and also might take more loans (contributes to the "I" part). So these factors will tend to decrease a company's earnings substanstially and thus we derive a figure called EBITDA!
Should one assess a company based on this value? No. Generally while assessing the performance of a company there is no one single magic figure to look at; one has to look at the various figures and then arrive at a conclusion on how the company is doing.
It is tempting to conclude that for a company the Income (P&L) statement is the most important statement - since it denotes how much profit a company made. But it is not. The income statment doesn't account for CASH which is the most important thing to run a business! - doesn't profit = cash? sometimes yes and sometimes no!
Go back to the main contents page
Copyright © 2020 Sethu Subramanian All rights reserved. Reach me via email at ssbell @ gmail.com