Income statement or profit and loss report

Income statement or profit and loss report (in Finnish, tuloslaskelma)

Income statement or profit and loss (P&L) report is a table, which represents the financial results of the organization for a certain period on an accrual basis from the beginning of the year (usually for the 1st quarter, half year or the whole year). This report shows the key financial indicators of the company, such as revenue and different costs, as well as the final financial result. Using the main indicators of the organization’s activities such as turnover, variable and fixed costs we can calculate the financial result, determine whether we have got a net profit or loss from our business for the certain period of time.

P&L statement reveals the financial performance of a company and, thus, provides all needed information and data to perform the company's financial analysis. Information presented in P&L report allows to assess the changes occurred during the reporting period and compare the results to the previous one. You can compare, for example, the data of the current month or quarter with the corresponding period of previous year. Making the financial analysis and summarizing its results it is possible to identify and develop unused opportunities to increase the profits of the company and to raise its profitability.

Using P&L model it is possible to calculate contribution margin, gross margin or operating profit (loss).

Contribution Margin

Contribution margin is a sales revenue minus its total variable costs:

1. Contribution Margin = Revenue - Variable Costs

What is the economic and finance meaning of this indicator?

This finance indicator can be easily understood and interpretation is the following: Contribution margin shows what is the maximum profit that a company can generate. The greater the contribution margin, the higher the ability of an enterprise to cover its fixed costs. The main task of managers and analysts of the company is to fulfil a continuous work for increasing contribution margin.

2. Contribution margin as a percentage (%) = total contribution margin / total sales

Using this ration, it is possible to reveal how a contribution margin affects net income.

Let's consider the following example:

• our company has got 1000 € in sales
• variable costs = -750 €
• thus, contribution margin = 250 €
• contribution margin ratio = 250 € / 1000 € = 0,25 or 25 %

We can make the following conclusions and assumptions:

• if our sales will increase up to 1500 €, then net income rises by 375 € = 1500 € * 25 %
• and, on the contrary, if we would like to increase net income by 1500 €, then we have to get in sales 6000 € =1500 € / 25 %

Thus, contribution margin affects the formation of net profit of the company. If contribution margin is negative, it is not advisable to produce and sale this product!

Contribution margin depends on two indicators: price and variable costs. Thus, if you would like to increase contribution margin, then at least one of these figures have to be changed. In other words, you have to raise prices or reduce variable costs.

Gross margin or operating profit (loss)

The gross margin is calculated as a percentage of the total sales income (total revenue) that are left over after incurring all direct costs associated with the production of goods and service providing. Gross Margin (GM) is a financial indicator that shows the efficiency and profitability of the company, i.e. its financial health. Using GM, we can assume, estimate and understand if our sales are good enough or not.

Gross Profit Margin = Gross Profit / Net sales

Gross Profit = Net Sales - Cost of Goods Sold (COGS)

Gross Profit Margin = (Net Sales - COGS) / Net Sales

(Note, that Gross Profit typically does not include fixed costs. And although Cost of goods sold (COGS) refers to the direct costs of producing the goods and the direct costs are typically variable costs, they can also include the fixed one.)

Cost of Goods Sold or COGS means the direct costs referred to the product or service creation, which has been sold.

Let's see an example:

• Your company has got a total revenue from sales 1000 € for one quarter and the COGS = 650 €. Thus,
• your Gross Margin in euro: 1000 € - 650 € = 350 € and
• Gross Margin in %: 350 € / 1000 € = 0,35 or 0,35 * 100 = 35 %

• It shows how efficiently your company can gain revenue from direct costs
• As a rule, the higher the gross margin percentage, then the healthier business and it is the better for your company
• In order to check if your final result is adequate you can compare it with an average data that is specific to your business industry (industry norms)
• Profit Margin for a startup sometimes can be lower and it is an ordinary situation
• Company's Gross Margin can be also negative. What does it mean?
  
  
  1. You can get such a result if your costs of production exceed total sales that usually means management disability to control company's costs. When GM is negative, you lose money non-stop! Costs of production exceed total sales if there is:
     • decline in revenue or
     • increase in expenses

     There are some reasons that lead to decline in revenue:

     • decline in sales
     • low pricing of a product or service
     • marketing fails
     • increased competition

     Reasons of increasing in costs:

     • raw material cost increase
     • labor cost, associated with the production, increases
     • recession and rise in interest rates as macroeconomic factors
  2. Do not forget that GM indicator can turn to negative because of natural things, for example, macroeconomic issues.

Income statement is a subject of careful consideration by: managers, investors, banks, partners and all stakeholders who work with the company. The information presented in the income statement allows the company's stakeholders to make conclusions about organization effectiveness and to get economic justification for investing in its assets.

Income statement or Profit and loss (P&L) report, free download template in Excel format

English, Russian and Finnish versions

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