© In

stitu

to In

tern

acio

nal S

an T

elm

o, 2

012

UNDERSTANDING THE P&L STATEMENT

P&L Statement

PROFIT & LOSS account Sales- Cost of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

The Profit & Loss Statement, P&L account, or simply P&L, contains four different parts:

The first part is related to the day-to-day operations of the business: what is bought and sold, and the activities necessary to run the business. The result of operations is the EBITDA.

P&L Statement

PROFIT & LOSS account Sales- Cost of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

The Profit & Loss Statement, P&L account, or simply P&L, contains four different parts:

Ordinary Operations

Depreciation is the recognition of the loss of value of our fixed investments as a consequence of use, obsolescence, etc. But although it is an expense, it does not have an impact on cash, i.e. we do not pay for depreciation expenses every year. The money went out when we made the investment. Therefore, it is not an item on which we can act once it has been committed.

P&L Statement

PROFIT & LOSS account Sales- Costs of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

The Profit & Loss Statement, P&L account, or simply P&L, contains four different parts:

Ordinary Operations

Consequence of investment decisions

We pay interest because we have debt. So, paid interest is a consequence of the financial decisions adopted by the company, which are usually taken without input from operating managers.

P&L Statement

PROFIT & LOSS account Sales- Cost of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

The Profit & Loss Statement, P&L account, or simply P&L, contains four different parts:

Ordinary Operations

Consequence of investment decisions

Consequence of financial decisionsTaxes are determined by governments. We must consider taxes in our decisions because we have to pay taxes but we cannot do that much to change them.

P&L Statement

PROFIT & LOSS account Sales- Cost of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

The Profit & Loss Statement, P&L account, or simply P&L, contains four different parts:

Ordinary Operations

Consequence of investment decisions

Consequence of financial decisions

The government

Let’s look in greater detail at the items that

summarise the ordinary operations of the business

Ordinary Operations

P & L Sales- Cost of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

Sales.Sales drive the evolution of almost every other item in the P&L account. Needless to say, they are very important.

What do we need to observe about sales:• The figure• Their evolution over time. Are they growing

or decreasing?• Seasonality. Are they homogeneously spread

over calendar months?• Stability. Are there bad years and good years?

The P&L shows the monetary amount of sales. But if sales in $ increase (or decrease), this may be because the amount of units sold increases or because unitary prices increase (or both).

Ordinary Operations

P & L Sales- Cost of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

Cost of goods sold & gross margin.Undoubtedly, sales are important. But what really matters are the gross margins obtained when we subtract the cost of goods sold (CGS). Growth of sales is worthless if it does not imply growth in the money finally earned.

Gross margin comes form two elements: price of sales and cost of the product or service sold. In every business, there are products with higher margins than orders. So, whenever aggregate margins are seen to vary, this may be explained by different causes:

• The variation in the unit prices obtained.• The evolution of costs.• Changes in the mix of products sold.

GROSS MARGIN = SALES – CGS

Ordinary Operations

P & L Sales- Cost of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

Cost of goods sold & gross margin.Undoubtedly, sales are important. But what really matters are the gross margins obtained when we subtract the cost of goods sold (CGS). Growth of sales is worthless if it does not imply growth in the money finally earned.

Gross margin comes form two elements: price of sales and cost of the product or service sold. In every business, there are products with higher margins than orders. So, whenever aggregate margins are seen to vary, this may be explained by different causes:

• The variation in the unit prices obtained.• The evolution of costs.• Changes in the mix of products sold.

GROSS MARGIN = SALES – CGS

Note:“Managerial accounting” studies different techniques for estimating the costs of products and services. These techniques exceed the scope of this block. You will find an introduction to them in the third block of this on-line course.Nevertheless, you need to understand how costs are computed before reaching conclusions on margins and making decisions to improve them.

Ordinary Operations

P & L Sales- Cost of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

Cost of goods sold & gross margin.Undoubtedly, sales are important. But what really matters are the gross margins obtained when we subtract the cost of goods sold (CGS). Growth of sales is worthless if it does not imply growth in the money finally earned.

Gross margin comes form two elements: price of sales and cost of the product or service sold. In every business, there are products with higher margins than orders. So, whenever aggregate margins are seen to vary, this may be explained by different causes:

• The variation in the unit prices obtained.• The evolution of costs.• Changes in the mix of products sold.

GROSS MARGIN = SALES – CGS

Are our margins good? • Compare them with those of competitors (benchmarking).• We must at least compare the gross margin obtained with the

money expended on operational expenses. The margin does not need to cover them but must be large enough to let us make some money in order to maintain investment, pay taxes and lenders and have a reasonable return for shareholders.

Ordinary Operations

P & L Sales- Cost of goods sold= Gross margin- Operating Expenses= EBITDA- Depreciation= EBIT- Interest= EBT- Taxes= Net Profit

Operating expenses.Operating expenses – OPEX – incorporate other expenses incurred by ordinary activities that are not included in CGS, e.g. salaries or overheads. They normally include sales and marketing expenses, administration costs, research and development expenses, etc.

They only include expenses which we will pay, i.e. they imply cash movement.

EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization.

EBITDA Margin

• EBITDA is the result of ordinary operations considering every element of income or expense that implies cash movement. It may be considered as “operating profit”.

What does EBITDA measure?

• EBITDA is a proxy of the cash generated by operations without considering investment activities or financial activities. We say “a proxy” because it is not real cash: certain income cannot be collected currently, some payments may be pending, purchased material may be in stocks, etc.

Why is it useful?

• Calculate total operating income and subtract every cost or expense related with ordinary operations and which you must pay.

• EBITDA = Sales – CGS - OPEX• Beware: EBITDA is not a standard concept, defined by any

accounting standards, hence different criteria exist for its calculation.

How do we calculate it?

© In

stitu

to In

tern

acio

nal S

an T

elm

o, 2

012