Investing in Philippines: Going Fundamental: Profit and Loss Statement

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Tuesday, October 25, 2011

Going Fundamental: Profit and Loss Statement

source: http://www.nvbc.org


Profit and Loss statement which is also known as Income/Loss Statement, Statement of Performance, Operations report, and better known as P&L is a summarize report of the company's earnings cost and expenses for a given period which is usually a year or fiscal year.

So why should you know what is in this statement?

Basically this statement tells you if the company is making money. It also tells how the company uses its resources well to generate income thus it is sometimes called Statement of Performance or Operations report. 

Like the Balance Sheet it has a basic equation:   



Earnings may come from sale of goods or services. For a retail company like National BookStore its earnings come from the sale of books and school supplies. For SM Malls most of their earnings come from space rental while ICT operates various ports and bill their customers for services rendered.

Now there is a must differentiation we must know when it comes to cost and expenses.

Cost is define as the value forgone to acquire more value. Say what is that again? Sorry for the gibberish definition. In simple terms cost is the value you give away to get more.

Lets make an example. If you are in a retail business which is the simple "sari-sari store" the money you use in purchasing your "paninda" is the cost. 

Now lets make it complicated. If you are in the manufacturing business the money use to purchase the raw materials and the labor you paid to make your final product are part of the cost of the product your business is selling.

But you ask me, that is like expense right? That is "I paid something" so it is an expense.

It may be like an expense and most interchange the meaning of these two words. But now you know that there is a difference between these two specially if use in deciphering important ratios in fundamental stock analysis.

So lets define expense properly.

Expense is a an outlay/outflow of resource(which could be money or a promise to pay) for services or other purchases that the company needs in its conduct of its business.

Again, it's too deep.

Expense are outflow to make sure the company operates, period. So expenses indirectly affect the company's product or service. A retail store may pay rent but it does not directly affect the value of the goods that it sells. 

I guess here is a better way of explaining cost and expenses. A company only have cost when it sells while the company pays expenses with or without a sale. In our previous example the retail store still pays the rent even if it did not sell a single product for the whole month.

Now in the equation if we deduct cost to the earnings(in most reports it is named sales, service or revenue) we arrived at Gross Profit. Gross Profit is the basically the markup on the direct cost of the product or service the company is selling. It tells us basically two things; first it tells how efficient the company is in using the limited supplies and labor and second it tells us how competitive the company is in terms of pricing.

We can see how efficient a company in using limited resource in the reflected Gross Profit. Let us say that the company can only sell its product at 100 pesos and in the past years the cost to make this product is 80 pesos thereby a 20 peso Gross profit or 20% markup. Now if they have a markup of 40 pesos in the same product sold still at 100 pesos that means they have reduced the cost to manufacture the product to 60 pesos giving them a higher Gross Profit of 40%. 

2 comments:

nestie said...

Very nice post, Im currently reading a book now on how to look at financial statements

nestie
www.wealthbuildingphilippines.com

Louis Delos Angeles said...

Thank you Nestie! What book are you reading? It might help others as well in understanding and in how to read the very alien thing called "Financial Statements"

Again thanks!!

Chitika