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Chapter 3
The profit-and-loss statement
Because the P&L gets the most attention, that’s where we’ll start. Recall that this statement measures the activity of a company over a period of time — a month, a quarter or a year.
This statement may have several different names — profit & loss, P&L, income statement, statement of revenues and expenses or even the operating statement. The P&L basically tells you revenue, expenses, profit and loss. In almost all circumstances, profit is not the same thing as cash flow as the two are measured under separate sets of accounting rules. This distinction is critical, as we’ll discover in later chapters.
The basic formula for the profit-and-loss statement is:
Revenues – expenses = net profit
The P&L may provide more detail, especially in the expenses section, but that’s the basic formula. P&L statements generally follow this format:
Revenues
- Operating (variable) expenses
= Gross profit (operating) margin
– Overhead (fixed expenses)
= Operating income
+/– Other income or expense (non-operating)
= Pre-tax income
– Income taxes
= Net income (after taxes)
Accountants sometimes combine operating expenses, overhead expenses and other with other expenses into one huge category. It’s best to separate them because each measures a different aspect of management’s effectiveness. Regardless of how expenses are broken down, however, all are still deducted before reaching net income.
Accountants might show only very summarized numbers in the P&L. If so, you must look for the supplementary information to determine what’s in each summarized total. (More on that in Chapter 11.)
Detailed internal P&Ls could contain a dozen or more columns, reporting individual months side-by-side, this-month-this-year versus this-month-last-year and year-to-date comparisons for the most recent month and the year-to-date.
Experienced financial managers sometimes simplify the P&L because too many columns make it confusing to read. But the latest software packages let you print the same P&L in three or four formats.
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Years Ended December 31 |
1997 |
1998 |
1999 |
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Operating Revenue |
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Freight revenue |
$6,750,000 |
$7,250,000 |
$7,423,500 |
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Contract carrier |
645,000 |
675,000 |
698,000 |
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Mileage lease charges |
127,500 |
145,000 |
154,300 |
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Sales of fuel, parts, and labor |
48,500 |
75,300 |
87,500 |
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Vehicle rental income |
15,800 |
17,900 |
19,700 |
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Total Operating Revenue |
7,586,800 |
8,163,200 |
8,383,500 |
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Operating Expenses |
7,227,500 |
7,675,300 |
7,823,500 |
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Operating Income |
359,300 |
487,900 |
559,500 |
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Other Income (Expenses): |
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Other income |
65,000 |
45,000 |
59,800 |
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Interest Expense |
(49,000) |
(53,000) |
(74,000) |
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Total Other Income (Expenses)-net |
16,000 |
(8,000) |
(14,200) |
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Earnings Before Income Taxes |
375,300 |
479,900 |
545,300 |
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Income Taxes |
(150,120) |
(191,960) |
(218,120) |
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NET EARNINGS |
$225,180 |
$287,940 |
$327,180 |
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Example of a P & L Statement
STATEMENTS OF EARNINGS
The P&L in detail
Now, let’s learn about what each of the major categories on the P&L contains:
Revenue is the money you receive for your services. Note that this is the gross amount before you pay drivers or freight brokers.
As we’ll discuss in later chapters, how you measure revenue depends on your method of accounting. Cash basis accounting counts revenue when the check is deposited to the bank or when it arrives in the mail. Most companies use accrual basis accounting, however, meaning that you count the revenue when the haul is completed, even if your customer takes 30 to 60 days to pay.
Operating, or variable, expenses are the expenses that vary directly with sales volume. In other words, operating expenses generally would rise or fall depending on the number of hauls or miles your fleet runs each month. Fuel, for example, would be zero if your fleet is idle. Drivers paid by mile or by percentage obviously fall into this category.
Other operating expenses vary roughly with revenue, over time, but not necessarily as directly as fuel or paid-by-the-mile drivers. Examples include pay for hourly or salaried drivers, payroll taxes and benefits for company drivers, travel and food allowances, certain types of insurance, tires, oil and most maintenance.
Gross profit margin or operating margin is the amount left when you subtract operating expenses from revenues. Many financial officers convert the dollar amount to a percentage of revenues. If revenues in a month were $1 million, for example, and variable costs totaled $750,000, then your gross margin would be $250,000 or 25 percent.
Gross margin is critical because it reflects management’s ability to (a) select quality hauls on good routes with adequate revenue, (b) control deadhead mileage and (c) control variable operating costs.
Overhead, or fixed, expenses are costs that don’t vary much month to month and don’t rise or fall with the number of miles you put on trucks. Examples include office staff salaries, owner compensation, related payroll taxes and benefits, rent, occupancy costs, such as utilities, certain insurance coverage and all other costs of doing business, except interest and taxes.
This category does NOT include the full amount of your monthly debt payments, even though they are almost certainly fixed. As we’ll learn later, these payments include both principal and interest, and only interest appears on the P&L. (In Chapter Seven, “Depreciation Methods,” we’ll see that a portion of the cost of trucks is deducted as a fixed cost, and this dollar amount almost never equals the amount of the principal you pay on the loans.)
Certain leases are treated as if they are really debts, if it’s likely that you will take ownership at the end of the lease term. Accountants treat these capital leases almost the same as if you’d borrowed the funds from the bank, with only the interest portion of the lease payment deducted on the P&L.
To confuse you even more, the full amount of certain leased equipment is included as an expense on the P&L. Leases that are considered to be pure rentals of trucks or trailers are fully deducted as an expense.
Operating income is income after deducting operating and overhead expense. Financial managers use it to measure profit generated from operating activities, such as running a trucking fleet.
Other income or expenses (non-operating) generally don’t relate to the operating side of the business, rather to how the management finances the business. It may contain non-operating revenue (interest or dividends from company investments, for example) or non-operating expense (for example, costs of borrowing, interest, factoring charges on accounts receivables advances or penalties). By separating these out, the accountant tries to isolate managers’ performance by separating revenues and expenses they can’t control.
Pre-tax income is just that: income before federal and state government take their share. This just excludes income tax; payroll, fuel, and other excise taxes are counted in pretax income.
Income taxes are calculated only after all other expenses have been deducted. In Chapter Nine, we’ll discuss how the P&L treatment of income taxes varies greatly with the type of legal entity of your company. For example, a C corporation almost always shows a healthy income tax expense, but S corporations, partnerships, LLCs and sole proprietorships rarely show income tax expense on the P&L.
Net income (after taxes) is the final amount on most profit-and-loss statements. It simply represents the net total profit earned by the business during the period, above and beyond all related costs and expenses.
The statement of retained earnings
Accountants usually present a statement of retained earnings, either at the bottom of the P&L or as a separate sheet in the annual report. Sometimes, it’s contained on the balance sheet in the equity section. The statement of retained earnings generally follows this format:
Net income (after taxes)
- Dividends paid
+/- Prior period adjustments
= Net change in retained earnings for the year
+ Retained earnings at the beginning of the year
= Retained earnings at the end of the year
A company has retained earnings if it has earned a profit in one or more years and has yet to distribute all of the profit to the owners. This sum is part of the owner’s investment in the company, in addition to amounts put in as capital. To grow, companies must retain a healthy percentage of their earnings and reinvest in the company. Each year, retained earnings grow by net income, and shrink by any owner withdrawals or net losses.
Prior period adjustments are necessary if an earlier P&L contains an error not previously corrected. An income tax audit or discovery of a significant mistake in revenues or expenses could lead to such an adjustment. This change for the current period is added to or subtracted from the beginning of the year retained earnings to arrive at the end of the year amount.
In Summary
The P&L measures the company revenues, less expenses for a period of time. It may cover a month, a quarter, or a year, and the format may vary, but the basic formula of computing net income remains the same for all P&Ls: Revenue minus expense equals net profit.
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