PROFIT AND LOSS ACCOUNT TEMPLATE UNDER THE INTERNATIONAL FINANCIAL REPORTING STANDARDS
In the following post, the P&L template under the International Financial Reporting Standards will be explained. The template is provided in the table below for a period of 4 fiscal years. Please note that t=0 is that start-up operators and all the expenses that happen at this momento of time should be recorded in the fiscal year t=0.
The P&L is one of the most important financial statements and provides information of the financial performance of a company in a period of time, usually one fiscal year (“FY”). It records the income from sales and the expenses incurred by the company to have that level of sales. The bottom line of the P&L is the net income or profit that remains for the investors, that can be paid as dividends (“Pay-out”) or reinvested into the company (“1-payout”). The reinvestment+payout must be 100%=net income.
The other 3 key financial statements are: balance account (a static photo of how the company gets funding, Equity and Liability, and in which Assets it employs this funding), changes in equity (that shows how the shareholders of the company change over time) and the cash-flow statement (provides information how the company generates cash-flow from operations, investments and financing activities).
Many authors consider that the P&L, the net profit is an “opinion” and the cash-flow generated by a company a “fact”, and I share this point of view. Due to the accounting standards and assumptions taken, the net income of a company can be different. Net income could be impacted by D&A lifespan of non-current assets, provisions, inventory methodology, etc; but the cash-flow or “real money” generated by a company is a fact.
After this introduction and consideration, that cash-flow is the “king”, let’s explain the different items of the P&L. As the P&L can be calculated for a period of time, we could have a monthly, quarterly, semi-annual or yearly P&L. Let’s assume a yearly P&L for 4 fiscal years as it is the case.
- Net sales=turnover=income. It is calculated as selling prices excluding VAT*the number of units sold. If the Retail Selling Price (RSP) that includes VAT is 11€ and the VAT a 10%, the price excluding VAT would be €11/(1+10%)=€10 per product/service sold.As the sales plan for the fiscal year is 60,000 units/hamburgers sold, the yearly net sales= €10*60,000 hamburgers=€600,000.
- COGs (Cost of Goods Sold). This item, depending on the cost accounting system used by the company could be considered as: (1) Direct cost (expense that only takes into account the manufacturing costs of the product/service, either variable or fixed), (2) Direct variable cost, taking into account only the manufacturing costs per unit sold. Usually any manufacturing process uses 3 types of resources: (1) R1, raw materials, (2) R2, operator, (3) R3, machinery. If we estimate the usage of R1, R2 and R3 per product/service manufactured, the COGs per unit manufactured can be calculated. Imagine that we sell hamburgers, and the ingredients used in 1 hamburger (bread, lettuce, beef, tomato, etc cost €1 (R1). The monthly salary of the person that prepares the hamburgers including social security paid by the company is €1,000 per month and works 160 hours per month (9,600 minutes). This “operator” employs 5 minutes of time to prepare the hamburger, therefore the cost of personnel per hamburger manufactured would be 5 minutes*€1,000/9,600 minutes=€0.5208 (R2). Japanese define the cost of the operator per minute as “souchin” (souchin=€0.1041 per minute). In order to prepare the hamburger, different machineries are used, and the company has estimated that one machinery usage, called as “Cost per shot, cps” is €0.04791 and preparing 1 hamburger requires 10 usages of the machinery (“number of shots per hamburger”). Therefore the cost of machinery would be cps*number of shots=€0.04791*10shots=€0.4791 (R3). In this example the COGs=R1+R2+R3=€1+€0.5208+€0.4791=€2 per hamburger sold. The COGs is usually provided in percentage over selling price excluding VAT, in this case it would be €2/€10=20%. This calculation is very important as we can compare the COGs of our company against others and analyze causes of deviations. Imagine that the competitors COGs on average is 15%. Why do we have a COGs that is +5% greater in absolute terms? The reason is because our supply procedures/ingredients are more expensive, do we pay higher salaries or our technology is not efficient? As the sales plan for the fiscal year is 60,000 units sold, the yearly COGs= €2*60,000 hamburgers=€120,000.
- Net sales minus COGs provides information of the “Gross Profit”, or profit the company obtains taking into account only the manufacturing process of goods and services. In this case it would be €600,000-€120,000=€480,000.
- SG&A. Now it is time to take into account the other business functions of a company that are not directly related with manufacturing. By SG&A we refer to the operational fixed costs related to selling, general and administration. In the following post the SG&A is explained in detail. SG&A considers expenses such as: salaries, social security paid by the company for that level of salaries, services outsourced to other companies (“external service providers”), rentals, facilities and utilities, software licenses used, marketing and promotion expenditures, transportation and delivery expenses of the products/services dispatched, insurance premiums, taxes paid excluding corporate taxes, etc. Imagine that our company has 5 employees, with a gross monthly salary of €1,000, the social security paid by the company is 30% (salaries and wages+social security=5 employees*12months*€1,000*1.3= €78,000). The company has a marketing budget of €12,000 per year and pay a monthly rent of €2,500 (€30,000). The total SG&A would be €78,000+€12,000+€30,000=€120,000.
- Gross profit minus fixed operational expenses=EBITDA (“Earnings Before Interests, Taxes, Depreciation and Amortization”). This is one of the most important metrics of profit of a business, as it analyzes how good or bad is the profit generation of a company taking into account only the “company operations”, with a breakdown of manufacturing and non-manufacturing business functions, and not considering the financial and country frameworks that are not directly linked to how good/bad is a business for the own nature of the business. For this example, the EBITDA is €480,000-€120,000=€360,000. This is profit the company generates taking into account only the manufacturing process and fixed costs but excluding financial expenses, loss of value of the non-current assets and corporate taxes paid to the government. EBITDA=€360,000=€360,000/€600,000=60%.
- Now it is time to calculate the EBIT (“Earnings Before Interests and Taxes”). In this post, it is explained what’s a non-current asset and the different types. It is also known as “operating profit”, and it is conceptually very similar to the EBITDA with one very import remark, it is a level of profit that takes into account how the non-current assets of a company loss value every year. This loss of value is called “Depreciation and Amortization, D&A” and depends on the level of investment in non-current assets undertaken by the company (expansion and growth plan) and the expected lifespan of this non-current assets. , but it is important to know that this type of assets are considered as the fixed infrastructure of the company, they will be held more than a year and without them it would not be possible to manufacture and sell our product/service. Let’s imagine that our company requires to invest in the following non-current assets: (1) Intangible assets: trademark registration, €1,000; website and software development, €15,000; (2) Tangible assets: store refurbishment and furniture, €134,000. The total amount invested in non-current assets, defined as “CAPEX” (capital expenditures) would be €150,000. If these non-current assets have an estimated lifespan of 5 years, the yearly D&A or loss of value assuming a linear depreciation would be CAPEX/lifespan=€150,000/5=€30,000. Therefore the EBIT would be EBITDA minus D&A=€360,000-€50,000=€310,000=€310,000/€600,000=51.66%. Please note that the EBIT could be “manipulated” as the net profit due to changing the lifespan of the non-current assets or the stock accounting procedure (related to COGs calculations). From this perspective the EBITDA value could be more important than EBIT.
- As mentioned before, up to EBIT, we have analyzed how good/bad is the company due to the own nature of the business. Now it is time to analyze other external factors that can impact business performance, such as cost of financing sources with explicit cost (such as a banking loan) and other incomes of financial nature (interest paid for the cash deposited in the bank account. The result of financial income minus financial expense is called “financial profit”. The financial profit usually is a loss, as many start-ups do not have financial income, and only generate an expense for the banking loans borrowed. Let’s assume that the company required funding to start the business for €226,100 (this is called total funding needs of a project) and this funding is provided 86% by investors/shareholders (€194,446) and 14% (€31,654) by a 3 years banking loan with a yearly cost of interests of 5%. The financial expenses or interest cost for the first fiscal year would be 5%*€31,654=€1,583. Taking this into account, the financial profit would be a financial loss of €1,583; and the “EBT” or “Earning Before Taxes” would be EBIT minus financial expense (€310,000-€1,583=€308,417). An EBT of €308,417 or 51.40% (€308,417/€600,000) means that the company makes a profit of 51.40% of the total net sales before paying taxes to the government. The EBT of €308,417 means the company makes profit if we consider manufacturing, selling, general, administration, depreciation of assets and financial business functions but excluding the corporate taxes that any company that makes profit must pay. The fiscal framework depends on the country, for start-up projects in Spain, the first two years a company created and if certain conditions are met, the corporate tax would be 15%. Afterwards, the general corporate tax level is 25%. Let’s assume that the company pays a 25% corporate tax (“T”), the taxes paid would be 25%*€308,417 =€77,104.
- Net income is the profit that remains for investors or shareholder of the company, as is calculates as EBT minus corporate taxes paid. In this case €308,417-€77,104=€231,313 or a 38.55%. This means that out of €100 of sale, the company generates €38.55 of net income for the investors. The shareholders of the company can decide to pay dividends, define by the ratio “payout” or reinvest into the company the profits. Let’s imagine that the payout is 30%, then the dividends paid to shareholders would be 30%*€231,313=€69,394 and the reinvested amount would be R=70%=>70%*€231,313=€161,919. Payout policy is decided by the general assembly of shareholders and it is one of the key management decisions: (1) Do we want to reinvest into the company the profit to generate future growth or (2) Do we prefer to to get paid dividends, drilling resources from the company in order to get cashflow payments to the investors?
Please note that we have calculated up to here the P&L for the fiscal year t=1. If we want to forecast the P&L for the following fiscal years, we should take into account:
- Sales forecast or units we are estimating to sell in the following years.
- Pricing policies: will the price remain the same or will be increased/reduced?
- SG&A: We should increase SG&A expenses by estimated inflation. This would make sense as every year some expense items are increased by inflation, at least raw materials costs and salaries. It would make sense to increase the other SG&A items by the inflation, excluding social security, as this is 30% of the salaries/wages and will indirectly be increased in salaries/wages are increased by inflation. Inflation estimations can be obtained from international bodies such as International Monetary Fund, Eurostat, European Central bank, Federal Reserve, OCDE World Economic Outlook Report, etc.
The evolution and analysis of the P&L items over time is called “horizontal analysis” and within a fiscal year, “vertical analysis”. These two analysis are usually undertaken in percentage basis and making a comparison against the competitors and industry in order to benchmark against comparable peers. A net income of 38.55% can seem to be high, but if the peers average net income is 50.55%, we are less efficient in a 12% absolute basis, and causes of deviations should be analyzed.
DATA CALCULATIONS FOR THE EXAMPLE EXPLAINED