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The purpose of this article is to explain the contents of Profit or Loss Statement which can then be used for ratio analysis to analyse the company’s financial performance. As ratio analysis use many figures from Profit or Loss statement, without understanding this statement properly it would not be possible to carry out an accurate and comprehensive financial analysis of the company. 

This statement is one of the two primary statements which financial accounting produces, other one is Statement of Financial Position (Balance Sheet) which we will discuss next.

This statement presents two elements of financial statements, income and expense. If income exceeds expenses, the net figure of this statement will be a profit, usually written as “(Net) Profit for the year.” However, if expenses exceed incomes then the final figure will be shown as a loss which is given in brackets. 

Before getting into more details, first, let get our head around the name of this statement as you would see different titles being used for this statement in the annual reports of different companies. As Profit or Loss Statement is a very recent change to the name of this statement, most of the annual reports would name this statement as “Income Statement.” The traditional name for this statement was “Profit and Loss Account. 

What is consolidated Income statement?

in Published financial statements given in annual reports, you will also see word “Group” or “Consolidated” before income statement. This is the case where one set of financial statements is being presented together for more than one companies as a “Group”.

Most of the big companies whose financial statements we use to carry out ratio analysis are large public limited companies (PLC) which own many other companies large and/or small private limited companies (PVT) called subsidiary(ies). Normally a subsidiary is either a part of owner company’s (called “Parent” company) operations or supply chain. Accounting regulations require parent companies to present statements of all those companies which it controls as one set of financial statements by adding their number together as it were a single entity (plus some complicated adjustments). This process is called consolidation, hence the word “Consolidated (Group) Income Statement.” It is possible to obtain financial statements of parent companies only if complete data i.e., financial statement including notes are available, only then ratio analysis cab be carried out for an individual company. However, annual reports which are more detailed and easily obtainable are usually published for the whole group mostly do not include full data for individual companies. Therefore, it is advisable that ratio analysis should be carried out for the whole group, if the company is a part of the group as not all public limited companies are in a group.

Dissection of Income statement

Looking at the face of the “Profit or Loss Statement”, the first thing which you would notice is that there are two columns for the financial data with a date given as a header. One column is representing the latest accounting period date and the second column would be representing the data for the year before. The previous year’s data is given as a comparative which is a requirement of international Accounting Standard IAS 1. However, in fewer cases you would see even three years’ data given which is due to changes made by a company retrospectively. However, for financial analysis, we don’t need to get into the details for the reasons behind it. One thing which often confuses students is the change in comparative figures. For example, a company shows its operating expenses figure for 2019 in its annual report for 2019 as £1.5 million. However, in its annual reports for 2020, the figure for 2019 (as the previous year’s figure is always given) shows as £1.3 million.

So why the different figures for the same thing in different years? The reasons behind these type of adjustments can be various. one of the reason could be the sale of part of the business which had operating expenses of £0.2 million. As that part of the business is do not exist in 2020, to make the data comparable, all figures for that part are removed from the comparatives. To keep it simple, you should use the data given in the latest version of the annual reports. If you are carrying out an analysis for 2018-2020, take 2018 figures from 2019 reports and for 2019 and 2020, use annual reports for 2020.

There is another column there headed “Note” and you would see numbers like 1, 2 or 3 etc. given in that column. This is a reference to the notes section (5th component of financial statements) which explains and gives more details on the figures which are given in the Profit or Loss statement. 

The “Revenues” is the first figure which is given in the Profit or loss statement. Sometime it is written as “Turnover” or “Sales” which are the different terminologies for the same concept. Revenue represents the income which is earned by carrying out the main function of the business. For example, Tesco PLC sells thousands of products in its stores. It also sells insurance services, sells fuels on its petrol stations and more. All of the income made through these sources would be classified as sales proceeds and would be given in this figure. The note given against revenue figure gives us a breakdown of this figures as per segments of the business.

These segments are usually derived by the geographical locations of the business or the different functions of the business. For example, if you look at the revenue note for “Super Dry PLC”, separate figures for revenue have been provided for retail and wholesale. These are two separate streams of revenues for this company. Burberry PLC segments are “Retail/wholesale and “Licensing” whereas Marks and Spencer give separate data for their Clothing, Home and other departments. This information can be very useful in some instances and given due to the requirement of segmental reporting by IASB. For example, when calculating/ locating “credit sales” figure which is required by few ratios.

If a business earns any income which is not from their main operations, it would not be included in the revenue figures. For example, if interest has been earned on the cash kept in the bank or if part of the building has been sublet to another business for rent, this will not be considered as revenue unless business is in lending or property letting industry respectively. There are many companies now which receive government grant and/or subsidies which are also included in other income.

“Cost of sales” is the second figure which you would see on Profit or Loss Statement. Cost of sales represent cost associated with the goods which a business sell. For a company which buys goods from other manufacturers, this figure is cost of purchasing that item plus cost of bringing the goods in to the warehouses plus storing it in the warehouse but not in the shops. However, for manufacturers, this cost can be very complicated and may include cost of many types of raw materials, paying for all of the factory expenses and labour to manufacture goods etc. Usually companies do not provide a breakdown of this figure due to commercial sensitivity of it, hence no further analysis could be carried out. However, there is an equation which can be used to breakdown this figure a bit further:

As opening and closing inventories are given in the financial statements, it is possible to work out the figure for purchases which is needed to calculate some of the ratios. This should also be noted that companies in normal circumstances would like to keep their inventory levels consistent. Therefore, if there is no change in opening and closing inventories (or just a small change then)

For some ratios, the figure for credit purchases is needed and it can be assumed that all of the purchases or credit as big companies usually trade on credit with their suppliers. 

Cost of sales is a direct cost which means it can be avoided if a certain sale is not made. For example, if Tesco sells a box of chocolate for £5, they would have to buy it first and pay some cost, let’s say £2.50. This £2.50 is cost of sales for that box of chocolate. However, in case of service-based businesses there is usually no cost like this. A service-based business would usually have its set up like buildings, machines and workforce which are available whether or not a sale is made. Hence these costs would not be avoidable and would constitute as operating costs which we will discuss below.

Therefore service-based businesses, for example, airlines and mobile companies like Vodafone, they usually do not give a figure for cost of sales. This is usually because these companies don’t have any cost of sales as they don’t buy anything to sell. Even if they do buy some stock e.g. airlines provide food to their customers which counts as inventory, this cost is so small that there is no benefit in giving this figure separately. 

One final thing about cost of sales figure given in profit or loss statement is that the figure will be given in brackets. Brackets in this case represent that this figure is being subtracted from the above figure and not that this figure is negative. Some of the students take this figure as negative incorrectly and mess up their ratio calculations. 

The third figure which we would usually see in Profit or Loss Statement would be “Gross Profit” which is calculated as

Gross profit is an important figure for many sectors e.g. manufacturing and retail businesses. However, for services-based businesses, this figure is usually irrelevant and you may not see this figure in the in the Profit or Loss Statement of these businesses. We will discuss this concept in details while calculating “Gross Profit Ratio.”  

After Gross Profit, you may see a Figure for “Other Incomes” which represents monies received other than revenues and not from the core operations after business. This figure is usually not relevant, however, in some cases this may include profit or loss on sales of an investment or property which can be helpful in explaining some ratios.

If this figure is given as negative I.e., in brackets, it means there was a gross loss. In this case, negatives should be used for ratio calculations unlike Cost of sales figure above.

The next figure which we can see is “Operating Expenses” (sometimes given with the word “net” before it) representing the expenses which were incurred to carry out the business’s main operations, e.g. administration, research& development, marketing and distribution. A trend in operating expenses should be noted as this figure can have an impact on some ratios.

Deducting operating expenses from gross profit gives “Operating Profit” figure. This figure is very important as it is used in many ratios. Operating profit is also called “Profit before Interest and Tax (PBIT). This terminology can be understood by looking at the income statement which shows interest and tax being deducted from operating profit. Hence the name profit before interest and tax. We will discuss in details on how operating profit can help us to understand the financial performance of a business while analyzing the ratios where this figure is used.

If this figure is given as negative I.e., in brackets, it means there was a gross loss. In this case, negatives should be used for ratio calculations.

After operating profit, we would mostly have a figure for “Finance cost.” This represents interest cost which business has paid on the loans it has taken for financing purposes rather than trading. In some annual reports, you might see a bit more detail given in this area, for example, finance income which could be a result off a short-term deposit made in the bank as there was spare cash available for the short term. Normally this income is given as “other incomes” above.

However, all those businesses which carry out a business of lending money, for example banks and High Street lenders, would record the interest earned as “Revenues” and not as finance income as lending is their main operation.

Finance cost is important in “Gearing ratios” areas and we will discuss it in more details when we will be calculating gearing ratios. The Figure for finance cost would be given in brackets which means it is being subtracted from operating profit resulting in the figure for profit before taxation. 

“Profit (Loss) before taxation” is profit which business has achieved after accounting for all of it operating and financing activities. It is an important element to assess the performance of the business.  If this figure is given as negative I.e., in brackets, it means there was a gross loss. In this case, negatives should be used for ratio calculations unlike Cost of sales figure above.

Taxation will be deducted from profit before tax. This figure is usually different from the tax liability given in Statement of Financial Position. Generally, Tax is beyond management control as corporation tax rate is set by the government. Therefore, this figure is not relevant to the financial analysis. However, management of companies usually use techniques to save tax payable but data on these is never given.

“(Net) Profit for the year (or Loss)” is usually the final figure given in the Profit or Loss Statement which is calculated as

If this figure is given in brackets, it will be a loss otherwise it is a profit. A loss is the only figure from Profit or Loss Statement which can be used as negative in ratios calculations which would give the result in negative too. This figure is an important result to assess the performance of a business and is used in various ratios which we will discuss in details later in this book. 

As far as financial analysis and the calculation of ratios is concerned, the above is all the information which we needed from Profit or Loss Statement. However just below the profit for the year figure, you would mostly see a breakdown of this figure into “controlling” and “non-controlling” figures. This is not relevant to ratio analysis so should be ignored. 

You will also see a figure called “Earnings per Share (EPS)”. This is a ratio which gives us the amount of profit (earnings) or loss made by each share of the company. The actual calculation of this ratio can be complicated. However, the good news is that we don’t have to calculate this ratio as it is always given just below the Profit or Loss Statement. We will discuss this a bit more in our section on investment ratios to get a good understanding on this as this ratio is an important one and this is the reason for this ratio being given in the financial statements. 

After Profit or Loss Statement you will see another statement called “Statement of Comprehensive Income”. This statement includes figures on the profit and loss made in the areas which are usually beyond the control of the company e.g. foreign exchange movements. As this information is not relevant for financial performance, this part of the statement should be ignored. 

This statement is actually a part of Profit or Loss Statement and some time this part is given attached to Profit or Loss Statement rather than a separate one. In fact, full name for Profit or Loss Statement is “Profit or Loss Statement and other Comprehensive Income” which would be used if both statements are given as one.

This article is written by Raja Mizan who is a senior lecturer in accounting & finance in a UK university. He is an ACCA member and also runs his own accountancy practice RMR Accountants & Business Advisors.

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