Please enable JavaScript.
Coggle requires JavaScript to display documents.
TOPIC 3: Analysing the P&L Statement (Key Areas Relating to P&L…
TOPIC 3: Analysing the P&L Statement
Importance of P&L statement
I
A firm is supposed to generate sales & earn profit
the value of a firm is determined by its earnings (size & quality of earnings)
Info alone is not a sufficient indicator
Income measured is on
accrual
basis rather than
cash
(means income ≠ cash generated over the reporting period)
Earnings Quality
Size
of Company's earnings refers to amount of profits earned by the firm
(Higher profit ≠ better)
Company's profits determined by a number of variables
(a) Choice of accounting policies & estimates)
•Inventory Valuation Method (FIFO, LIFO) •Depreciation Method (Straight/Accelerated) •Provision for Impairment of Receivables
(b) Discretionary expenses
Eg: Training, R&D, Advertising, Repairs & Maintenance
(c) Timing of revenue & expenditure (income shifting)
•Accelerate revenue •Delay expense recognition
(d) Non-recurring / Exceptional item
(e) Effect of cyclical & economic forces
Quality
of earnings refer to the extent that the company's reported results accurately reflects the performance of the biz (
Overstating profitability)
Earnings Power
Ability of a firm to sustain its past/current earnings w/ some degree of regularity over future periods. (affected by nature of the different sources of income)
Factors affecting: Raw materials, Labour strikes, Technological changes, Changes in product mix
Key Areas Relating to P&L Analysis
(1) Revenue/ Sales
(a) Major sources of Sales
by means of a common sized statement (%)
(b) Stability & Trends of Sales
• Nature of products/ services
(general economic/ biz conditions •Customer tastes & preference •Availability of substitues
•Quality of Management
("predict" trends, introduce new products
•Degree of Diversification
(Product, Customer, Markets)
• Degree of Dependance on "star" salesmen
(c) Methods of revenue recognition & measurement
(2) Cost of Goods Sold
cost of materials used, wages of production workers, depreciation of PPE & other expenses
(3) Operating Expenses
(a) Selling - variable VS fixed
Advertising & Promotion, Salary & commission, Depreciation
(b) Administrative
Staff costs, Accounting/ Audit cost, Insurance premiums, Depreciation (Admin offices)
(c) Bad Debts
(4) Depreciation
(a) Evaluation of Dep.
(b) Methods of Dep. (straight/ Accelerated)
(5) Maintenance & Repairs
(a) Evaluation of R &M cost
(b) Evaluate together w/ Dep. Exp
(6) Interest Expense