Financial Statements: Profit & Loss

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At its very core, any business is essentially management of money .The language of money is finance. Therefore it is important for all practicing and budding managers to have a working knowledge of the financial statements. This will help them deal with the finances of the Corporates better. The present article seeks to introduce financial statements and cover the profit & loss (P & L) statement in detail. Let us start by understanding the role of financial statements.

Q1) What is the role of financial statements?

Ans. Financial Statements play an important role as they give a picture of the state of the business. There are primarily three main financial statements. These statements are:

1. Profit & Loss Statement.
2. Cash Flow Statement.
3. Balance Sheet.

The study and analysis of each of these statements reveals three important dimensions of the business.

Q2) Which are the important business dimensions that financial statements indicate?

Ans. The Profit& Loss statement (P & L) indicates the profitability of a business. The Cash Flow statement is equally important as it indicates the liquidity position. Finally the Balance Sheet statement indicates solvencyof the firm.

Q3) Why is the P& L statement important?

Ans. As we are aware, the fundamental purpose of any business is to make profits.The P&L statement is important as it indicates the profitability of the unit. It broadly indicates the income earned and expenses incurred by the business entity over a period of the time. The P & L statement captures all the business activities during aspecified period. In case of MNCs this period could be a calendar year (Jan to Dec). In case of Indian companies this period is thefiscal year (April to March).

Q4) What is the starting point ofthe P & L statement?

Ans. The revenue or Income generated is the starting point of P&L. The revenue earned is therefore called as Top-line as it appears on the top of the P & L statement. A firm can earn revenue either through its core activities or by way of other income.A good blue chip firm should show consistent growth in its value driver that is the core income of the firm.

Q5) What is core income of a firm?

Ans. The core income of a firm is the income earned from the basic activities,for which the firm was formed. These activities are as defined in the financial charter of the firm. In India the financial charter is known as Memorandum of Association (MOA) and Articles of Association (AOA). An easy way of identifying core activities of a firm is to note that the incomes from these activities are normally recurring in nature. This is not the case with other income for a firm.

Q6) What is other income for a firm?

Ans. As the name indicates, other income is the income earned from activities other than the basic core activities. It is to be noted that other Income is normally non-recurring and is often one time income. A classic example of other Income is the income received by a manufacturing firm on sale of its real estate. This is obviously an one time income for a manufacturing firm. On the other handsale of real estate would be core income for a real estate company as it is their core activity.In order to arrive at profitability one should deduct the expenses incurred from the income of the firm.

Q7) What are the various expenses incurred by the firm?

Ans. The expenses incurred by the firm can be broadly classified as:

1. Production Expenses.
2. Administration Expenses.
3. Selling & Distribution Expenses. (S&D )
4. Research & Development Expenses. (R&D)
5. Miscellaneous Expenses.

It is important to analyse each expense in detail as it will help in understanding the cost drivers of a firm.

Q8) What are the cost drivers of a firm?

Ans. In general, it is found that20%of expenses in number, constitute 80% of total costs in value of the firm. Such main expenses which are small in number but contribute significantly to the total costs are called as cost drivers. For example in IT firms, expenses on salaries and wages are significant and thus are itscost drivers. On the other hand, in manufacturing units, expenses on raw materials and power are significant and thus will be its cost drivers.In case of FMCG companies, Selling & distribution (S&D) expenses could be one of the cost drivers. The identification of cost drivers helps in Strategic Cost Management.

to be continued......

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