What is the P&L Statement?

Warren Buffett has called accounting “the language of business.” If you want to invest like he does, you must learn the nuances of accounting.

An excellent place to start is a company’s P&L statement, which stands for profit and loss statement.

The P&L statement is synonymous with a company’s income statement, and the two terms are often used interchangeably. This is one of three crucial financial statements that investors must understand.

The purpose of the income statement is to show whether a company is profitable by showing its operating results over a period.

How to read a P&L Statement

The statement starts with a business’s revenue and concludes with the profits or losses.

Let’s quickly walk through a P&L statement to see how these results are obtained.

Revenue is at the beginning of the P&L statement. It is a company's total sales after accounting for all discounts, rebates, and other paybacks.

For instance, if Domino's Pizza sells a large pepperoni pizza for $12 but runs a 50% off special for the NFL opening weekend, it only records $6 of revenue for each pepperoni pizza it sells during that special.

From revenue, we subtract a company’s cost of goods sold (COGS). COGS includes all expenses incurred to make its product or deliver its service, including raw materials, paying suppliers, employee costs, and equipment depreciation. 

For our Domino's Pizza example, COGS would include dough, cheese, and sauce costs.

Subtracting COGS from revenue results in gross profit. Gross profit is the total profit before operating expenses and is one of the more important numbers on the P&L statement.  

We must take out various operating expenses from gross profit, such as research and development (R&D) and selling, general, and administrative expenses(SG&A).

For our Domino's Pizza example, operating expenses include spending on TV commercials and its corporate kitchen to dream up new pizza recipes.

After backing out things like R&D and SG&A, we are left with operating profit. Often also called operating income, this is the profit surplus that a company earns after all business expenses. This makes it a very important figure!

Some non-business expenses remain to reduce operating profit before we arrive at the company’s net income. This includes interest, which the company pays the bank or bondholders for any debt it carries on its balance sheet.

This result gives us EBT, or earnings before taxes. This figure is helpful because it highlights the impact of taxation on a company’s earnings.

Finally, we subtract taxes from EBT. This includes all federal, state, and local taxes a business pays.

This gives us our long-awaited result: net income, which is also commonly referred to as earnings or profits.

P&L Terms and Synonyms

Also, remember that a lot of these terms can be used interchangeably with others. So don't be confused when companies or investors use language that means the same thing by studying this sheet!

In your search for great investments, the income statement can provide many clues beyond whether a company is profitable. It reveals whether a company uses a lot of debt to fuel growth or needs to spend a lot of money on R&D to maintain its competitive advantage.

Understanding these key terms and how each was reached will help you become a better investor.

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