The profit and loss (P & L) statement or income statement

The Profit and Loss Statement is one of the three financial statements in annual reports and is usually the one that is most frequently looked at. It describes how the company has done over the past period in terms of sales and profits. The P & L usually begins with Sales or Revenue at the top and is followed by all sorts of costs until we arrive at net profit. The following is usually how the P & L is arranged:

1) Sales or Revenue
2) Cost of Goods Sold (COGS)
3) Selling, General and Adminstrative Expenses (SG&A)
4) Operating Income or Operating Profit
5) Recurring Income or Recurring Profit
6) Extraordinary Gain or Loss
7) Profit before Tax
8) Net Profit

Perhaps it suffice to say in this post that the most important no. to look at is 4) Operating Profit (or EBIT: Earnings before interest and tax). This no. is basically the profit that the firm has booked after it has subtracted all relevant costs that are incurred in doing its business. Below operating profit, no.s are subjected to manipulation and hence become less reliable. (That doesn't mean that the operating profit cannot be manipulated though, in fact, everything from Sales to Net Profit can be manipulated, that is why integrity of management is so important.)

In recent years (esp so during the dot.com boom), a lot of listed co.s could not even generate a positive operating profit (i.e. their core business was losing money after factoring in the relevant operational cost). Hence analysts invented another no. called EBITDA which stands for Earnings before Interest, Tax, Depreciation and Amortization. This means that if we do not take into account depreciation cost, the co. is making money.

To put it in another light, say you bought an ice-cream machine that cost $200, you use it to make ice-cream selling for $1 and you declare that you made $200 after selling 200 ice-creams. The cost of the ice-cream machine? Doesn't matter, as long as EBITDA is concerned. Depreciation cost for the ice-cream machine is not a cost under the definition of EBITDA.