Module for Investors
5. Reading profit and loss statements - terms and meaning
As an investor, to fundamentally analyse a company, you need to be able to read through and understand the financial statements of the entity. And among the three main financial statements of a company, the profit and loss statement gives you an overall picture of a company’s operations.
Since you’ve already been briefly introduced to the profit and loss (P&L) statement in module 2 of Smart Money, we’ll delve right into the specifics here. In this lesson, we’ll be taking up the real profit and loss statement of a company to try and understand the various terms in the report along with their meanings.
Reading through the profit and loss statement
Here’s a snapshot of the P&L statement of Hindustan Unilever Limited (HUL) taken from its annual report for the year 2019-2020. Since it is important to familiarise yourself with the layout and the structure of a profit and loss statement, take a moment to read through this statement.
Now that you know what a profit and loss statement looks like, let’s take up each section and try to understand what it means.
By law, the profit and loss statement of every company is required to clearly state the period to which the statement pertains. In our example, as you can clearly see right at the top of the statement, it pertains to the year ended 31st March, 2020 (which translates to the financial year 2019-2020).
In addition to that, on the top right corner, you will also find the currency denomination. In this case, the denomination is in rupees and in crores. So, any number that you read in the statement is essentially in rupee crores. For instance, the number 500 on the statement would mean Rs. 500 crores.
The P&L statement of a company is usually divided into 4 columns, as follows.
- Particulars: This column consists of the names of the categories of transactions that the company has undertaken. These transactions are represented numerically in the columns on the right.
- Note: This column consists of numbers that are assigned to the various categories of transactions. More in-depth details of these categories can be found in the ‘notes to the financial statements,’ under the number assigned to it.
- Year ended 31st March, 2020: This column consists of all the amounts pertaining to the current financial year in question, which in this case is 2019-2020.
- Year ended 31st March 2019: All the amounts pertaining to the previous financial year are mentioned in this column. Here, that means the year 2018-2019.
The ‘income’ header consists of two primary subcategories, namely the revenue from operations and other income. Let’s delve a little deeper into these two.
Revenue from operations
Also known as the top line of a company, this header consists of all the revenue earned by a company through its primary operations. In our case, since Hindustan Unilever Limited is a manufacturer of FMCG products, it derives its revenues from the sale of its various products. Here’s a snapshot of the relevant note (note 24) that goes into further detail.
Looking at this note, you can see that the company has also been rendering services to its customers and deriving income from it. This has been classified under the head ‘other operating revenue,’ including other ancillary income from its day-to-day operations.
The income generated by a company through activities other than its main business are categorised as ‘other income’ in the P&L statement. Let’s take a look at its relevant note to understand exactly what this header is composed of.
As you can see, the company has generated dividend income from its investments in its subsidiaries, and also through various investment options such as interest. All of these activities are not a part of the company’s main operations.
By adding both the revenue from operations (Rs. 38,785 crores) and other income (Rs. 733 crores), you get the total income of the company, which is Rs. 39,518 crores.
As the name suggests, the ‘expenses’ header of the P&L statement contains all the expenditures made by a company in a financial year. Usually, these expenses are classified according to their nature. Here’s a more in-depth look into these expenses.
Cost of materials consumed
This line item pertains to the costs of the raw material used in the manufacture of the company’s products.
Purchases of stock-in-trade
This includes the costs involved in the purchase of finished goods for the purpose of trade or resale.
Changes in inventories of finished goods (including stock-in-trade) and work-in-progress
The line item pertains to the changes in the opening and closing inventories of finished goods, stock-in-trade, and work-in-progress.
Employee benefits expenses
All the costs incurred by the company for the benefit of its employees are consolidated under the ‘employee benefits expenses’ tab of the P&L statement. Here’s a breakup of the various expenses under this tab, as specified under its relevant note (note 29).
Also known as borrowing costs, these are essentially interest expenses and other ancillary costs that a company incurs when it borrows funds. The breakup of the various finance costs incurred by HUL is presented in note 30. Here’s a snapshot.
Depreciation and amortisation expenses
Any asset, whether tangible or intangible, loses its value over the years due to wear and tear. This loss in the value of a tangible asset is known as depreciation. The loss in the value of an intangible asset is known as amortisation.
Since the assets of a company reduce in value every year, the relevant loss is accounted for in the P&L statement as an expense. In this case, HUL has incurred depreciation and amortisation expenses amounting to Rs. 938 crores during this year alone.
The ancillary and miscellaneous expenses incurred by a company are all clubbed together under the header ‘other expenses.’ Note 32 of the financial statements of HUL goes into the details of these items and gives a complete breakup of all the other expenses incurred by the company.
Summing up all of the expenses we’ve seen above, it becomes clear to us that HUL has incurred an expenditure of Rs. 30,229 crores in the current financial year alone.
Profit before exceptional items and tax
The amount that a company ends up with after subtracting its total expenses from its total income is termed as ‘profit before exceptional items and tax.’
In our example, HUL’s ‘profit before exceptional items and tax’ stands at Rs. 9,289 crores (Rs. 39,518 crores - Rs. 30,229 crores).
Exceptional items (net)
Any income or expense that is unusual and non-recurring, but still arising from normal day-to-day activities of a company, is usually termed as ‘exceptional income or exceptional expense.’
All the exceptional income and the exceptional expenses incurred by a company are netted off. This net amount is then adjusted against the line item ‘profit before exceptional items and tax’ to end up with ‘profit before tax (PBT).’
If the exceptional expenses of a company exceed its exceptional income, the total of the exceptional items is reduced from the profit before exceptional items and tax. Conversely, if the exceptional income of a company exceeds its exceptional expenses, the total of the exceptional items is added to the profit before exceptional items and tax.
Let’s take a look at note 33, which clearly lays out the exceptional items in HUL’s financials.
As you can see here, the exceptional expenses exceed the exceptional income. After netting off, HUL ends up with Rs. 197 as exceptional expenses.
Profit before tax (PBT)
The net of the exceptional items is reduced from the ‘profit before exceptional items and tax’ to arrive at the ‘profit before tax.’ In this case, the PBT is Rs. 9,092 crores (Rs. 9,289 crores - Rs. 197 crores).
The ‘tax expenses’ header consists of both current and deferred tax payments made by a company in a financial year. According to HUL’s P&L statement, we can see that the company has made current tax payments amounting to Rs. 2,202 crores and deferred tax payments of Rs. 152 crores.
Profit for the year (PAT)
Also known as the bottom line of a company, the profit for the year is arrived at by subtracting the tax payments from the ‘profit before tax.’
In our example, after deducting the tax expenses, HUL’s profit for the year (PAT) stands at Rs. 6,738 crores (Rs. 9,092 crores - Rs. 2,202 crores - Rs. 152 crores).
Earnings per share (EPS)
As you’ve already read about in the lessons of previous modules, the equity shareholders of a company enjoy a claim on its net profits. Companies generally like to include ‘earnings per share (EPS)’ calculations in their profit and loss statement. This is done to give investors and potential investors an idea of how much each equity shareholder of the company would stand to gain if all the profits were paid out to them.
The EPS is calculated by dividing the total net profit of a company by the total number of equity shares outstanding. Here’s note 34 of HUL’s financial statements, which gives you an idea of just how the company arrived at the EPS value.
So, that brings our reading of a profit and loss statement to a close. It’s now time to see what you can do with the numbers in this financial statement. That’s just what we’re going to discuss in the next chapter.
A quick recap
- The profit and loss statement gives you an overall picture of a company’s operations.
- It shows all the revenue earned by a company through its primary operations and the income generated by a company through activities other than its main business.
- The expenses section shows you the cost of materials consumed, purchases of stock-in-trade, the changes in inventories of finished goods, employee benefits expenses, finance costs, and depreciation and amortisation, among others things.
- The net of the total expenses and the total income gives you the profit before exceptional items and tax.
- Netting off the exceptional items from that figure, you get the profit before tax (PBT).
- Deducting tax expenses from the PBT gives you the profit for the year or the profit after tax (PAT).
- The EPS is calculated by dividing the total net profit of a company by the total number of equity shares outstanding.
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