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MENTORING - FUNDAMENTALS - Company Fundamentals - P&L analysis -…
MENTORING - FUNDAMENTALS - Company Fundamentals - P&L analysis
When analysing a company or its management on a quantitative basis, accounting data stands in the forefront.
Under accounting data, investors or traders get quantitative information through: (a) Profit and Loss Statement (P&L); (b) Balance Sheet; and (c) Cash flow statement.
A P&L statement comes four times in a financial year (ending March every year in India for most companies).
That means a company releases a P&L every quarter-end (June-end, Sept-end, Dec-end and March-end).
Because a P&L is released most number of times it has a communicative value for traders. It is important for investors to know the progress of a company and its management. But because it is released more times in a year, it has a communicative value or news worthiness for trading.
That means a trader can find a trade or a discrepancy when a P&L is released.
Another reason why a P&L has a tradable value is because of its volatility. That means a P&L cannot be forecast exactly. There is always a variation between what the market (consensus) expects and what the company delivers. That difference can act as a discrepancy or an opportunity for a trader.
What are the components of a P&L?
There are three components in a P&L. (a) top line (revenue or sales and other income); (b) mid line (operating expenses); (c) bottom line (profits; there are various types of profits).
Revenue is the inflow of money at a current time (cash) or in a future time (credit) into the company.
Sales for which cash is received now and service or product is delivered now is called revenue. It brings cash immediately into the company. It appears under revenue account in P&L. This is a cash inflow.
Sales which are done on credit for service and product delivered now are called accounts receivables. For these, cash is received at a future date not in the current date.
The accounts receivable account stays in the balance sheet as an asset.
Growth in revenue is based on various aspects. Demand scenario for the company's products, and also many operational aspects.
Expenses, or the mid line, is an outflow of money for services or products bought or taken at a current time (cash) or in a future time (credit) or in the past (prepaid expenses or even depreciation and amortisation).
Expenses in cash go to the P&L. Expenses on credit, called as accounts payable, go to the balance sheet under liabilities.
Prepaid expenses or depreciation or amortisation are large and one time expenses, for which money is paid but services are received later - these all stay under the balance sheet under assets.
The fundamental rule is that revenue and expenses should be allocated properly to a product.
A business's efficiency lies in doing a proper cost allocation. That is where a company's strength lies.
If a company can allocate costs at a granular level, its expenses are always under control.
A company has two types of expenses: operating and non-operating or mandatory expenses, non-operating but non-mandatory.
Under our framework, we focus only on operating profit. That is the real profit that captures the behaviour of revenue and expenses.