The Study of Stock Market through Fundamental Analysis

Lesson -> Let's Understand The Profit and Loss Statement (Part 01)

4.1 - An Outlook of the financial statements

Two perspectives can be used to view financial statements:

  1. The maker's point of view
  2. User's Perspective

A maker prepares financial statements. A maker is usually an accountant. His duties include preparing ledger entries and matching bills and receipts, tally the inflows and outflows, as well as auditing. The final goal is to create transparent financial statements that accurately reflect the company's financial position. Certain skills are necessary to prepare such a statement. These skills are usually acquired through rigorous training programs for Chartered Accountants.

The user, on the other hand, needs to be able to comprehend what the maker has prepared. He is only the one who uses the financial statements. He doesn't need to know all the details about the audit procedures or journal entries. He is only interested in what is being said and how it can be used to help him make decisions.

Google is a good example of this. Google's backend search engine algorithm is complex and most of us don't understand it. We all know how Google works. This is how you can tell the difference between the user and the maker of financial statements.

Market participants often believe that the fundamental analyst must be proficient in financial statement preparation concepts. Although this knowledge is helpful, it is not essential. Fundamental analysts must be users, not financial statement makers.

A company must present three major financial statements to show its performance.

  1. The Profit and Loss Statement
  2. The Balance Sheet
  3. The cash flow statement

In the following chapters, we'll be able to understand each statement from the perspective of the user.

4.2 - The P&L Statement

Popularly, the is also known as the Income Statement, P&L statement, or Statement of Operations. The Profit and Loss Statement shows what happened over a period of time. The P&L statement provides information about:

  1. The company's revenue for the period (yearly, quarterly)
  2. These expenses are incurred in order to generate the revenue
  3. Depreciation and tax
  4. Number of earnings per share

My experience has taught me that financial statements can be best understood by reading the actual statement and deciphering the information. Here is Amara Raja Batteries Limited's P&L Statement (ARBL). Let's look at each line item.


4.3 - The company's Top Line (Revenue).

Analysts may have spoken of the company's top line. Analysts refer to the revenue side in the P&L statement when they say this. The company's first set of numbers in the P&L is the revenue side.

Let's first look at the revenue side before we get to the actual revenue.

The header clearly states:

  1. The statement of P&L (for the year) is an annual statement, not a quarterly one, as it was filed on March 31, 2014. It is also effective as of March 31, 2014.st2014 It is obvious that the statement refers to the Financial Year 2013-2014 or the FY14 numbers.
  2. Rupee Million is the unit of currency. Note: 1 Million Rupees equals 10 Lakh Rupees. The company can choose which unit to express its numbers.
  3. The particulars contain all of the main headings for the statement. The schedule also contains any associated notes to the particulars. It is located in the note section. The note is given an associated number (Note Number).
  4. When companies present financial statements, they default to reporting the current year number in the left-most column, and the previous year number in the right-hand column. The numbers in this example are for FY14 (latest), and FY13 (previous).

The revenue side's first line item is the product Sales.

We know that we are dealing directly with a battery company. The Rupee value for all battery sales during FY14 is determined by the sale of products. The company's sales total Rs.38.041,270,000/-, or approximately Rs.3,804 Cr. In the previous financial year (i.e. FY13.

Note: I will recite all numbers in Rupee Crore because I find it easier to understand.

Next is the excise tax. This is the amount that the company would pay the government (Rs.400 Crs); therefore, the revenue must also be adjusted.

After the excise duty, the revenue is adjusted to the following: Net sales. ARBL's net sales for FY14 were Rs.3403 Crores. For FY13, the same was true for Rs.2943 Cros.

The company makes revenue through services, as well as the sale of products. This could be the annual battery maintenance. For FY14, the revenue from services sales was Rs.30.9Crs.

At Rs.2.1crs, the company also includes "other operational revenues". This could include revenues from the sale of products and services that do not core to its operations.

The company's final revenue comes from the sale of products and services, as well as other operating revenues. Total operating revenue. This figure is Rs.3436 Crs in FY14 and Rs.2959Crs in FY13. It is interesting to note that a note numbered 17 titled "Net Revenue From Operations" will allow us to examine this aspect more.

Remember, we discussed in the previous chapter notes and schedules for the financial statement.

Below is a snapshot of note 17.

These notes provide a detailed analysis of the splitting-up operation revenues(Does not include any other income details. You can see in the details that section 'a" talks about the division under sales of products.

  1. For FY14, the price of storage batteries as finished goods is Rs.3523 Crs. This compares to Rs.3036 Crs for FY13.
  2. In FY14, the price of storage batteries (stock in trade), was Rs.208 crores compared to 149 crores. Stock in trade is the sale of finished goods from a previous financial year.
  3. Home UPS (stock in good) sales are at Rs.71 Crores FY14, compared to Rs.109 Crs FY13
  4. The net sales of products adjusted to excise duty amounts to Rs.3403 Cros, which matches the P&L statement.
  5. You can also see the revenue split between services and revenue. The revenue number of Rs.30.9 is the same as the one reported in the P&L Statement.
  6. The company notes that the "Sale of Process Scrap", generated Rs.2.1 Cr in revenue. The sale of process scrap is an incidental part of the company's operations and therefore reported under 'Other operating revenues'.
  7. Add all revenue streams into the company, and you get: We get Rs.3403 Crs+Rs.30.9 Crs+Rs.2.1 Cros net revenue from operations = Rs.3436 Crs
  8. Similar splits can be found for FY13.

You will notice that the P&L statement reports ARBL's 'Other Income' at Rs.45.5 Crs. Below is note number 18. It explains the meaning of the other income.

We can see that the income from other sources is income not directly related to the main business. This includes dividends, interest on bank deposits, insurance claims, royalties income, and dividends. The other income is usually a small part of the total income. An excessive amount of 'other income' is usually a red flag and should be investigated further.

We have FY14 total revenue of Rs.3482Crs if we add up the revenue from operations (Rs.3436 Cros) and other income(Rs.45 Cros).

To Summarize

  1. The financial statement gives information about the company's financial situation.
  2. The complete set of financial statements includes the Balance Sheet, Profit & Loss, and Cash Flow Statement.
  3. Fundamental Analysts are financial statement users. They need to understand the statements of the financial statement maker.
  4. The profit and loss statement shows the profitability of the company during the current year.
  5. P&L statements are estimates. Companies can change the numbers later. Companies publish data for both the current and previous years by default.
  6. The top line of a company is the revenue side of its P&L.
  7. The company's main source of revenue is from operations.
  8. Other operating income can include revenue that is not directly related to the business.
  9. Other income includes revenue, not from operating sources.
  10. The 'Net Revenue From Operations' is the sum of all revenue from operations (net duty), other operating income, and other incomes.