What is a P&L Report?
Profit & Loss Report (also known as Income statement) is a type of financial report that has one main purpose: To show how easy it is for a company to create new wealth.
Understanding the rationale of the report and learning how to use it can help you to understand how companies generate new wealth, help managers to improve the way the company generates wealth and more importantly, also can help you identify businesses that do generate wealth easily, opening the door to using this information to generate a lot of wealth for yourself and your family.
To understand how easy a company is generating wealth we can calculate the company profit margin. The profit margin is calculated by dividing the Net Income (Gross Income – Expenses) with the Gross Income. The higher the profit margin is the more easy it is for the company to generate new wealth.
To help you understand this, here is a real life example:
Let’s say that we have two people Jennifer and Mike.
Jennifer works for a law firm and she earns $270,000 annually, that sounds much but Jennifer has a lot of expenses and she end up with only $8,000 dollars profit, that is only 3% profit margin (8,000/270,000).
On the other hand Mike is a software engineer which earns an average salary of $110,000, but mike end up with $37,600 because he has way less expenses than Jennifer. That is 34% profit margin, which is a very good one.
So you have to understand that the Earnings are only one side of the story, you have to take into account the Expenses, as a rule of thumb the higher the profit margin, the better it is.
A couple of things to remember before you move on:
P&L is always done over a known time period: month, year, quarter.
P&L does not answer another question regarding wealth, which is, how much new wealth is generated from one’s asset or possessions’ value – less obligations. Check out Balance Sheet tip for more on that.« Back to Glossary Index