04. The profit and loss statement
The profit and loss statement, also called P & L, or income and cost, shows us the income of an organisation, and its cost. The cost is being subtracted from the income. What remains is the profit, or a loss. While the balance sheet shows the balance of assets and liabilities at a certain point in time, for instance on December 31 (only on that day), the profit and loss statement shows the income and cost of a certain period, for instance per day, or per week, or per months, or per year. This is important to check first, whether the numbers are for a period of a year, or otherwise.
Again I would just read slowly what the profit and loss statement shows.
First it will show various sources of income, also called revenues. Next those cost will be subtracted from the income which relate directly to them in the form of raw materials, or half ready products, or products at purchase price. The result shown then is called the gross income. Depending on the type of business the gross income has a certain relation to the total income. At a business I was involved in for many years we tried to manage for a gross income of above 30%, related to the total income. In other businesses the gross income should be above 50% or 54%. If a business makes like 80 million Euro revenues or more, it makes a big difference to the profit, if the gross margin is 54% or 53%. This is an important figure.
After the gross income, also called gross margin, the cost of personnel are shown and all the other cost. This will result in the next level of profit, the so called EBITDA, meaning Earnings Before Income-Tax Depreciation and Amortization. Then depreciation and amortization will be subtracted. Those type of cost relate to the investments done in the past. This results in the EBIT, meaning Earnings Before Income-Tax. From this income-tax and interest to be paid for loans will be subtracted. The result is then finally the profit after tax.
Many people in finance today measure the success of a company with the EBITDA. This may be 10% of the total revenues, or more, depending on the type of business. The argument then is that this number cannot easily be manipulated.
I would argue against it and would advise to measure the success of a company or initiative with the profit after tax, because the initiative can only be successful in the long-term when it also can pay for its necessary investments into either refurbishing and renewal of its assets, or into future products and services. And it also needs at all times to be able to pay for its taxes.
I have seen many young businesses who focus on the top level, meaning revenues. Today many internet based businesses measure their success by the number of clients they have. With a high enough number of clients they go to the stock exchange by way of an IPO, initial public offering, to raise more growth capital at very high valuations, without ever having made any profit. Some of those do succeed. Think about Amazon, which made losses over many years and now is a highly profitable business. But also many fail. For me this is a bit of a gambling business to do. I would prefer always to rather grow slowly but always profitable and as far as possible also self sustainable, being only little, or better not, dependent from bank loans.
In some young business I have been involved it has taken 3-5 years to train the responsible people to not look at top-line anymore but to always look at the bottom line, asking the questions like: do we make enough profit to sustain our business? Do we have enough cash at hand to survive a crisis?