MENTORING - Fundamentals - Company fundamentals - P&L risk - Coggle…
MENTORING - Fundamentals - Company fundamentals - P&L risk
For real money, there are three key risks from a company: (a) management risk; (b) P&L risk; (c) Balance Sheet risk
The P&L risk mainly comes from operational risk or management risk.
The Balance Sheet risk mainly comes from ecosystem or management risk
To avoid P&L risk, we should deeply analyse a P&L account for positives and negatives.
What is a P&L account? A P&L account takes into account all the revenues and expenses. These are flow variables. These are measured over a period of time.
There are two kinds of economic variables. (a) flow variable - one that is measured over a period of time; (b) stock variable - a variable that is measured at a point in time.
A flow variable is like a video of an event that happens over a period of time. A stock variable is like a photograph of an event that happens at a point in time.
So a company's performance is measured with respect to the performance of these variables between two points in time, that is a quarter or a half year or a year or many years.
The P&L has three parts: (a) top line, also called revenue; (b) mid line, also called expenses, and (c) bottom line, also called profits.
Revenue account comprises all accounts that bring in cash and forego products or services. That means cash is in, product/service is out.
Revenue brings in money.
Revenue that has not brought in cash will remain as accounts receivables in the Balance Sheet account.
Revenue is an important beachhead for a company to make money. This is linked to the ecosystem and operations. A good ecosystem and a great operational setup are what driven the revenue. So a company's revenue drivers lie in the ecosystem and operations.
Expenses are are the midline, like for a human being. Would you appreciate a human who has a very large midline?
For a company's top line to perform well, midline is key. Too much of midline and too thin a midline are always dangeours. Too thin a midline strangulates a company without power. Too much of midline brings death.
An important point to remember is for a company revenue source can be only one but expenses sources can be many.
Because revenue base is small (with one source of inflow or max two sources of inflows) and expense base is large with multiple sources of outflows, it is PARAMOUNT for a company to control expenses. Companies that have good expense control are fundamentally strong companies.
The faculty that deals with management of expenses with respect to revenue is called management accounting
The various sources of expenses are: (1) raw material; (2) inventory, (3) work in progress; (4) finished goods; (5) other operating expenses; (6) debt, in the form interest; (7) taxes; (8) employee expenses; (9) fuel and power; (10) depreciation and amortisation.
Expenses cannot be analysed by us, retailers or outsiders, at the granular level as companies do not share that data. So we will analyse expenses at a broader level and find a ratio that helps in understanding the revenue to expense behaviour.
Expenses can be: (a) direct or indirect expenses; and (b) fixed or variable expenses.