How To Analyze Profit and Loss statement Of A Company In India?

  • Post last modified:October 1, 2021
  • Post category:Stock Market
  • Reading time:14 mins read
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What Is Profit and Loss statement ?

As the name suggest Profit and Loss statement shows what has happened to revenue and expenses for a company during a particular time period. Items covered in the P&L statement give details about what has happened over a specific period of time in terms of profit and losses.

For example, one cannot declare what is the revenue as of a particular date, because revenue is generated over a period of time. However, it is important to specify over what period this revenue is generated.

The Profit and Loss statement is also called as the P&L statement, Income Statement, Statement of Operations, and Statement of Earnings.

In an annual report of a company, Balance sheet gives us an idea about the assets and liabilities of a company, as of a specific date. All the items defined in a balance sheet are as of a specific date. one can always specify the amount of assets as of a particular date.

Where as for profit and loss statement revenue, expenses, taxes, has to be of a particular time period.

 

How To Analyze Profit and Loss statement Of A Company?

If you want to know how to analyze profit and loss of a company one should be aware about the 4 basic constituents:

  1. The revenue of the company for the given period (yearly, or quarterly)
  2. The expenses incurred to generate those revenues
  3. Tax and depreciation
  4. The earnings per share number also known as EPS

For understanding purpose I have taken Tata Motors Limited (TML) Annual report, you can download Tata Motors Limited annual report here or even can get it from its website.

Standalone Financial statements represent the company’s standalone numbers/ financials and do not include its subsidiaries’ financials.

Whereas, the consolidated numbers include the companies (i.e. Standalone financials) and its subsidiaries financial statements.

Hence you should look through the consolidated financial statements as it represent the company’s financial position better.

Let us look at P&L statement of Tata Motors Limited (TML) to understand how it gets calculated, take a look at below image taken from its AR.

 

How To Analyze Profit & Loss statement Of A Company?

 

Let us first talk about first line item that is revenue side, this is also called as the top line of the company. The revenue side is the first set of numbers the company presents in the P&L.

Needles to say revenue comes from selling your product and services, and incase of TML as it is a vehicle manufacturing company its sales gets derived from same.

There is a note no 33 associated as you can see from revenue from operation, if we check this we will understood how they come to this number.

Take a look to the below snapshot showing the same:

 

 

As viewable TML have generated revenue of Rs. 2,49,794.75 crore by selling vehicle, spare parts, some services etc. The next is other income which include government grants, this is nothing but the incentives given by government to corporates, dividends, interest income etc.

Usually the other income forms (and it should) a small portion of the total income. If you see a large other income than do check the note no. associated as it usually draws creates a doubt, demanding a further exploration.

So, overall income or revenue for TML stands at Rs.252,437.94 if you add all three.

Next point of discussion is the expense side of the P&L statement. Take a look at the below snapshot showing the total TML expenses occurred.

 

 

The first line item on the expense side is ‘Cost of materials consumed’ this is inevitably the raw material cost that the company requires to manufacture finished goods. As you can see, the cost of raw material consumed/raw material is the company’s largest expense.

Purchase for product for sale refer to all the purchases of finished goods that the company buys towards conducting its business.

Where as Change in the inventory of finished goods refers to the costs of manufacturing incurred by the company in the past, but the goods manufactured in the past were sold in the present/current financial year.

Keep in mind if you see a negative number here it indicates that the company produced more units of vehicle in the FY21 than it managed to sell.

The next item on the expense side is “Employee Benefits Expense”. This is self explanatory as it includes expense incurred in terms of the salaries paid, contribution towards provident funds, and other employee welfare expenses.

Further down is Finance cost, it is interest costs and other costs that an entity pays when it borrows funds. The interest is paid to the lenders of the company. The lenders could be banks or NBFC .

Foreign exchange is also self explanatory, meaning the currency exchanges happened in last 1 year. However, do you see it is showing in bracket, this means its a negative number.

So, wherever you see any numbers shown in bracket in P&L Statement, take that number as negative. Following that, the next line item is “Depreciation and Amortization”.

To understand depreciation and amortization, first we need to understand the concept of tangible and intangible assets.

There are 2 types of assets, a tangible asset has a physical form and provides an economic value to the company for example, machinery, equipment’s, plants, a laptop, a printer, a car, etc.

Where as an intangible asset does not have a physical form but still provides an economic value to the company such as brand value, trademarks, copyrights, patents, franchises, customer lists etc.

Whether asset is tangible or intangible irrespective both has to be depreciated over its useful life. That is to say the period during which the asset can provide economic benefit to the company.

For example, the useful life of a machine could be 8 years.

Let us understand in brief about depreciation better with the help of the following example.

XYZ company generates Rs.100,000/- from its business. However, it incurred Rs.45,000/- towards the purchase of equipment which will be useful for the company. The economic life (useful life) of this tool or equipment is expected to be let say 8 years.

Now if you were to look into the earning capability of XYZ company it appears that on the one hand, it earned Rs.100,000/- and on the other hand, spent Rs.45,000/- and therefore retained just Rs.55,000/-.

This distort the earnings data for the current year and does not really reflect the company’s true earning capability.

Keep in mind that the asset even though purchased this year, would continue to give economic benefits over its useful life. Hence it makes sense to spread the cost of acquiring the asset over its useful life. This is called depreciation.

This means instead of showing an upfront lump sum expense (towards the purchase of an asset), the company can show a smaller amount spread across the useful life of an asset.

Thus Rs.45,000/- will be spread across the equipment useful life, which is 8. Hence 45,000/ 8 = Rs.5,625/- would be depreciated every year over the next eight years. By depreciating the asset, we are spreading the upfront cost.

Hence after the depreciation computation, XYZ firm would now show its earrings as Rs.100,000 – Rs.5625 = Rs.94,375/-.

Likewise for non-tangible assets the depreciation equivalent is called amortization and done in the similar manner. We will understand it better when we analyze the cash flow statement later on in the post.

The last line item on the expense side is “other expenses”  you can check the note number 37 to get all other expenses company have spent its money on. Adding up all the expenses mentioned in the expense side of P&L, it seems that TML has spent Rs.249,151.20 crore.

Now if we deduct total revenue from total expenses we get Profit/ (Loss) before exceptional items and tax, which by the way stands at Rs.3,286.74 cr for TML.

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What Is Profit Before Tax (PBT) In Profit & Loss Statement?

Profit Before Tax in short PBT refers to the net operating income after deducting operating expenses but before deducting taxes and interest. One also need to deduct exceptional item before arriving at PBT.

Exceptional items are expenses occurring at one odd time for the company, and the company does not foresee this as a recurring expense. Hence they treat it separately on the P&L statement.

We can see that TML has mentioned their profit before tax and exceptional item numbers in the P&L statement take a look below:

 

What Is Profit Before Tax (PBT) In Profit & Loss Statement?

 

Profit before Tax = Total Revenues – Total Operating Expenses

However if we see in above image the exceptional items are also there if we add and subtract (the no. in bracket are negative) will get the total exceptional item worth.

As we know, Profit/(Loss) before exceptional items and tax = Rs.3,286.74

Total Exceptional Item = 84.81+459.90+14994.30+114+(-1182.41)+(-663)+(-46.58) = Rs.13,761.02

Profit before Tax = 3,286.74 -(13,761.02) = -Rs.10,474.28

This means TML is in negative even before taxes, and if add taxes in this we will get the Profit After Tax for Tata Motors Limited (TML).

 

What Is Profit after tax (PAT) In Profit & Loss Statement?

Profit After Tax (PAT) is the net operating profit, it is defined as company operating profit after deducting its tax liability. This is the last part of the P&L statement, the profit after tax. This is also known as the bottom line of the P&L statement.

As you can see from the snapshot above, to arrive at the profit after tax (PAT), we need to deduct all the applicable tax expenses from the PBT.

All taxes together total upto Rs.2,541.86 Cr. However there is also Share of profit/(loss) of joint ventures and associates (net) which stands at -Rs.378.96.

Hence Net PAT = PBT – Applicable taxes.

PAT = -10,474.28 – (2,541.86+378.96) = Rs.-13,395.10 Cr

As we can see there are also non controlling interest of Rs.56.29 we have to add this to PAT to arrive at the final PAT for the year 2021 for TML. Hence, TML has total profit and loss for FY21 of about Rs.(-13,451.39).

A company can utilize profit after tax in three different ways:

  1. Entire amount can be distributed to shareholders of the company.
  2. Some part of it is distributed as dividend and some part is invested back into the company, for research or expansion.
  3. Whole profit amount is invested back into the company.

Start up companies usually tend to retain most of the earnings as they have enormous potential to grow and capture market share.

On the other hand, mature companies who have already grown a lot tend to distribute most of the income to shareholders in the form of dividends, due to lack of growth opportunities.

If you check the last 4 year net income i.e. P&L for TML, it was only profitable in the year FY2018.

At that time they have profit of Rs.8,988.91 cr, the major chunk of loss happened since 2019 onwards, that is why you also have seen shares of TML dropping to whopping Rs.67 from a high.

Pandemic added the fuel required fuel to skew it down to those level, although it have regained much now due to the last half year performance. The Other comprehensive income/(loss) does not be reclassified to profit or loss, hence one can avoid those numbers in P&L.

Let us now move on to the last part that is about basic and diluted earnings per share.

 

How To Calculate Earning Per Share(EPS)?

The earnings per share (EPS) is a very important number which indicates how much the company is earning per face value of the ordinary share. It is one of the most often used statistics in financial analysis. The last line in the P&L statement talks about basic and diluted earnings per share.

Let’s us take a look at below snapshot from TML P&L Statement, also see the associated note no.45 in the image:

 

How To Calculate Earning Per Share(EPS)?

 

Below is the associated note no 45 showing you the number of shares outstanding in the market for TML.

 

How To Calculate Earning Per Share(EPS)?

 

The Company has two classes of shares – the Ordinary shares and the ‘A’ Ordinary shares both of Rs.2 face value each. There is little difference between both in terms of voting rights and dividends.

Basic earnings per share (EPS) and diluted EPS are used to measure the profitability of a company. Basic EPS is calculated, taking into account the outstanding equity shares of the company.

Diluted EPS includes convertible shares such as employee stock options, warrants, debt in its calculation.

For example, if a company earned a net profit of Rs 100 crore and the total outstanding shares were 2 crore, then the EPS would be Rs 50 per share. However, this formula poses a problem.

Basic EPS takes into account only outstanding shares. A company may have other potential sources of dilution of equity. For example, a company may have issued warrants which, when exercised, will lead to dilution of equity.

Moreover, the company may have issued convertible debentures which if converted, could also increase the number of outstanding shares.

All such potential sources of equity dilution are taken into account while calculating diluted EPS. Thus, diluted EPS gives a clear picture of a company’s actual earnings per share.

Earlier, it was not essential for companies to declare diluted EPS. However, now we can see the diluted EPS in every financial statement of the company.

Having said that in above case of TML, Since there is a loss for the year ended March 31, 2021 and 2020, potential equity shares are not considered as dilutive and hence Diluted EPS is same as Basic EPS.

First let us take the weighted average number of Ordinary shares for Basic EPS, which stands at 3,128,268,742, now the profit and loss for these shares are Rs.- 11,570.58 cr.

Rs.- 11,570.58 cr divided by 3,128,268,742 gives approx. earning per share of Rs.-36.99, which means TML is not profitable company as of now as its EPS is negative.

Similarly, weighted average number of ‘A’ Ordinary shares for Basic EPS is also equals to -36.99 EPS. Just divide the total profit with total outstanding shares.

Now that we have gone through all the line items in the P&L statement, let us relook at it completely.

 

How To Analyze Profit & Loss statement Of A Company?

 

Now this statement may look more meaningful to you. Keep in mind, most of line items in the P&L statement will have an associated note. You can always look into the notes to get a better clarity.

I hope now you have the basic understanding of How To Analyze profit and loss Of A Company In India, But this is not the end, there are other 2 financial statements you should read and understand i.e. Balance sheet and Cash flow statement to gauge the complete knowledge about how company have performed in an financial year.

I do not want to make it a overdoes hence you can click on above link to know more about them in a detailed way.

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