Intro to PnLs

This is an introductory post to what a P&L is and how to read one. I will be sharing my cardinal rule when it comes to reading a P&L.

Every business activity leads to either of two things - money inflow or outflow. Since each of them have a financial implication, they are recorded carefully. This is overlooked by the Accounts team in the organisation.

In order to know where we stand, all the transactions are summarised at regular intervals.

Every organisation maintains the following two summaries aka financial statements.

1. Profit and Loss Statement (P&L) It shows all business expenses & incomes and helps to determine whether we made a profit or loss.
   

2. Balance Sheet It lists down the assets and liabilities of the business.

Let us have a look at the structure of a P&L

You must be thinking "Why has she highlighted the text and skipped the numbers?" But we before we approach "chal, paisa ni vaat kar", let me share the cardinal rule with you.

The # 1 Rule : Contex is key

If I come across any P&L which doesnt mention the time period/name of entity/units, I dont bother analysing it. The numbers are important only if they can be read with context.

Let us consider two scenarios:

Scenario 1 Radhika: My revenue is Rs 5Lacs You: Wow! Radhika: But, I earned that over 2 years. Does not wow you anymore does it? Scenario 2 Radhika: My revenue for the starting month is was 1Lac, but after 6 months, I am at 5Lacs. You: Okay, so you were able to grow your sales by 5x within 6 months. Sounds amazing! Do you see how you could draw a better sense of my progress when I provided you with time context? Similarly, entity name is critical. Is the P&L for the entire business or a particular product or a region? Make sure that you ask these questions before you dive into analysing the numbers. This brings me to my best practise for reading P&Ls - Always read the P&L from top to bottom and do not ignore the text. This sounds really silly, but if there is one thing that I have learnt from my year long experience of auditing, is this. For those of you who are interested in preparing P&Ls, most of the data collection will be dependent on context.

The Number game

As mentioned earlier, a P&L records both inflows and outflows. Expenses lead to outflow/drop in cash/bank and are recorded on the left side. Incomes make our cash/bank healthier and are recorded on the right side. Now let's apply our grade 5 logic here "is LHS = RHS?" (I sound like the kid from Byjus TV ad) If you add the expenses (totals to 75,000), you will realise that we have a surplus/profit of 25,000 (Sales - total expenses). Here's a better version of the P&L (aka, samjha bro?)

Summarising the summary

This is how I would wrap the entire P&L in <20 seconds for my manager:

1. Petite Fashion achieved a top-line of INR 1Lac in August, 2021.

2. Their bottom-line is 25% (25,000/1,00,000).

3. Cost of materials is their highest expense.

Now that I have slyly introduced the jargons, in the next post we will collate a P&L from stratch. Food for thought: Why would I highlight point #3 when its pretty obvious?