Sunday, April 6, 2008

Two commonly misunderstood financial statements

There are two commonly misunderstood financial statements which tend to generate loads of questions for people. So i decided to write a little article about them and clarify what they mean. I hope this will be helpful.

The profit and loss account

P&L Account

Sales Revenue

Cost of Sales

Gross Profit

Selling, General and Administrative Expenses
Earnings before Interest, Tax, Depreciation and Amortization 5,257
Depreciation and Amortization

Earnings before Interest and Tax

Interest expenses

Income Tax

Net Profit


Companies' annual reports contain a profit and loss account (commonly referred as P&L). This is a financial statement which shows the difference between the revenues and expenses of a period. Non-profit ( or not-for-profit) organizations such as charities, public universities and museums generally produce an income and expenditure account. If they have more income than expenditure this is called a surplus rather than profit.
At the top of these statements is total sales revenue or turnover: the total amount of money received during a specific period. Next is the cost of sales, also known as cost of goods sold (COGS): the costs associated with making the products that have been sold, such as raw materials, labour, and factory expenses. The difference between the sales revenue and the cost of sales is gross profit. There are many other costs of expenses that have to be deducted from gross profit, such as rent, electricity and office salaries. There are often grouped together as selling, general and administrative expenses (SG&A).
The statement also usually shows EBITDA (earnings before interest, tax, depreciation and amortization) and EBIT (earnings before interest and tax). The first figure is more objective because depreciation and amortization expenses can vary depending on which system a company uses.
After all the expenses and deductions in the net profit, often called the bottom line. This profit can be distributed as dividends (unless the company has to cover past losses), or transferred to reserves.

The cash flow statement

British and American companies also produce a cash flow statement. This gives details of cash flows - money coming into and leaving the business, relating to:
  • operations - day-to-day activities
  • investing - buying or selling property, plant and equipment
  • financing - issuing or repaying debt, or issuing shares.
The cash flow statement shows how effectively a company generates and manages cash. Other names are sometimes used for it, including funds flow statement and source and application of funds statement.
British companies also have to produce a statement of total recognized gains and losses (STRGL), showing any gains and losses that are not included in the profit and loss account, such as the revaluation of fixed assets.

No comments: