Let’s talk about profit,
let’s talk about loss, and let’s talk about the profit and loss statement!
Profit in green, because making a profit is good. Loss in red, because making a loss is not so good.
The main idea of profit and loss is to compare a company’s revenue to its expenses.
Simply put, revenue is the number of units sold times the selling price per unit,
across all the product lines that a company may have. Expenses are the number
of units sold times the cost per unit, plus operating expenses, plus interest and taxes.
When looking at profit and loss, it’s always about a period of time: a month, a quarter, or a year.
You record a profit if revenue exceeds expenses for the period. You record a
loss if expenses exceed revenue. Let’s look at real world examples of profit and loss.
One of the most profitable companies in the world is Apple. For the fiscal year ended September 24,
2022, Apple recorded a profit of $100 billion. One… Hundred… Billion… Dollars.
That’s a one with eleven zeros. Revenue of $394 billion far exceeded expenses of $294 billion.
What’s in this revenue number? $316B sales of products
(such as iPhone, MacBook, iPad, Apple Watch, AirPods) and $78B in services.
What’s in expenses? $224B cost of products and services sold, things like the components
going into the products, and the cost of labor and machines assembling the products.
$26B in research and development expenses, to develop new technologies to enhance existing
products and services, and to expand the range of the company’s offerings.
$25B in selling, general and administrative expenses, which includes the cost related to
general management, sales, marketing, customer service, human resources, finance, legal,
sourcing and IT. Another big expense component is $19B in corporate income tax expense.
Let’s take a look at Apple’s profit and loss statement,
or P&L, which is the way these numbers are officially presented to the outside world.
All the way at the bottom is the net income line: $99.8B to be precise.
All the way at the top of the P&L is the revenue, summarized at an aggregated level.
If we explore a section of the 10-K annual report called the Management’s Discussion and Analysis of
Financial Condition and Results of Operations, we can find more revenue detail by category.
Sales of iPhones alone brings in more than half of the $394B in revenue!
The expense section is over here. Various types of expenses have their own section in the profit
and loss statement, in a logical sequence, and several subtotals of profitability are provided.
The first subtotal is gross margin, which you calculate by taking $394B of revenue
minus $223B of cost of sales. What you sold your products and services for,
minus what it cost you to produce the products and perform the services. For Apple,
gross margin in absolute terms is $171B, and in relative terms (compared to revenue) 43%.
You get to that percentage by taking the $171B in gross margin and dividing it by $394B in revenue.
A second subtotal in the profit and loss statement is operating income:
$171B gross margin minus $51B operating expenses (which is the sum of the research and development,
and the selling, general and administrative expenses). For Apple, operating income in
absolute terms is $119B, and in relative terms (compared to revenue) 30%. You get to that
percentage by taking the $119B in operating income and dividing it by $394B in revenue.
The bottom line of the P&L is net income: revenue minus all expenses. $99.8B, or 25% of revenue.
Every profit and loss statement tells a story!
Most P&Ls have a “fun fact” that is worth noting. For me, the fact that Apple spends
$26B a year on R&D, which translates to only 7% of revenue, is mind-boggling.
Let’s go from a company that it is very profitable to a company that makes a loss:
Snap Inc, in its fiscal and calendar year 2021. They recorded a loss of half a billion dollars
(that number is between brackets to show it’s a negative),
as revenue of $4.1B was lower than expenses of $4.6B.
Here’s the profit and loss statement of Snap Inc. Net loss of $0.5B at the bottom.
Revenue of $4.1B at the top, this is mainly advertising revenue.
Expenses are in the middle, between revenue and net income. Snap Inc doesn’t give you Gross Margin
as a subtotal in the P&L, but we can calculate it ourselves by taking revenue and deducting
cost of revenue: $4.1B minus $1.7B equals $2.4B. As percentage of revenue, this is 57%.
Similar to what we did with Apple, we can calculate the percentages at the operating
loss level and the net loss level: minus 17% of revenue, and minus 12% of revenue. The “fun fact”,
or maybe for Snap Inc the “not so fun fact” in this P&L, is that the line other income helped
to limit the net loss. In other words, the net loss would have been far worse, if it hadn’t
been for the 240 million dollars of gains on strategic investments and marketable securities
that took place in this financial year. Profit and loss: comparing a company’s
revenue to its expenses, and then diving deeper to understand what is in revenue, and what is
in expenses, and analyzing the company’s profit and loss ratios to see how they’re performing.