Chapter 8 of 15
How to Read a P&L Statement
Revenue, expenses, net profit - company profitability.
Raksha could tell you, without looking at any document, roughly how her restaurant was doing.
"Last month, kitchen 1 did about ₹8 lakhs in sales. Costs were around ₹5.5 lakhs, groceries, salaries, gas, maintenance. So we netted maybe ₹2.5 lakhs before rent and taxes."
That's a P&L statement. She'd been building one in her head every month for six years.
Now she opened the annual report of a listed restaurant chain to decide whether to buy their stock. And the Profit & Loss (P&L) statement, also called the Income Statement, suddenly had ten lines she didn't recognise.
Let's map her restaurant's mental model onto the formal document.
What Is a P&L Statement?
The P&L statement (also called income statement) shows a company's revenues, expenses, and profit or loss over a specific period, typically a quarter or a full financial year. Unlike the balance sheet (a snapshot), the P&L is a movie, it shows what happened over time.
The P&L answers one question: did the company make money, and how much?
The Structure: Top to Bottom
The P&L flows from top (revenues) to bottom (net profit), with various costs subtracted at each stage. Each step gives you a different profit metric.
Revenue (The Top Line)
This is total money earned from selling products or services before any costs.
For Raksha's restaurant: total bills paid by customers. For a listed company: total sales billed to customers.
Revenue is when a sale is made, not necessarily when cash is received. If a company bills a customer ₹10 crore in March but the cash comes in April, ₹10 crore appears in this year's revenue. This gap between revenue and actual cash collection is tracked via receivables on the balance sheet. High receivables relative to revenue can signal revenue quality issues.
Gross Profit: After Direct Costs
Gross Profit = Revenue − Cost of Goods Sold (COGS)
COGS = direct costs to produce what you sell. For Raksha: raw food ingredients, packaging, direct kitchen labour. For a manufacturer: raw materials and direct factory labour.
Gross Margin = Gross Profit ÷ Revenue × 100
Gross margin tells you the basic profitability of the product/service before overhead. A falling gross margin means either raw material costs are rising or pricing power is weakening.
Kitchen 1: Revenue ₹8L. Direct costs (groceries ₹2.8L + kitchen staff ₹1.8L + packaging ₹0.3L) = ₹4.9L. Gross profit = ₹8L − ₹4.9L = ₹3.1L. Gross margin = 3.1 ÷ 8 × 100 = 38.75%. For a restaurant, gross margins of 35–45% are typical. If this falls to 30%, Raksha knows something is wrong, maybe food prices spiked or she's discounting too much.
EBITDA: Operating Profit
EBITDA = Gross Profit − Operating Expenses
Operating expenses = everything needed to run the business that isn't directly tied to production. For Raksha: rent, marketing, manager salaries, utilities, repairs.
EBITDA stands for: Earnings Before Interest, Tax, Depreciation, and Amortisation
Why EBITDA matters: it strips out financing choices (interest), tax jurisdiction, and accounting conventions (depreciation). It's the closest thing to "operating cash reality" for comparing companies across different geographies or capital structures.
EBITDA Margin = EBITDA ÷ Revenue × 100
For Indian consumer companies, EBITDA margins of 15–25% are healthy. FMCG can be 20–30%. Restaurants 12–20%. IT services 20–35%.
EBIT: After Depreciation
EBIT = EBITDA − Depreciation and Amortisation
Depreciation is the annual "wear and tear" cost of assets. Raksha's ₹18L kitchen equipment doesn't last forever, accounting spreads its cost over its useful life (say 10 years: ₹1.8L/year).
Depreciation is a non-cash expense, no money actually leaves the company. But it reduces reported profit.
A company can show strong EBITDA while secretly needing to replace aging equipment constantly (high "maintenance capex"). Look at free cash flow (operating cash flow minus capital expenditure) to see the real cash picture. Heavy depreciation with low reinvestment is fine; heavy depreciation with equally heavy reinvestment suggests the real cash profits are much lower than EBITDA implies.
PBT: After Interest
PBT (Profit Before Tax) = EBIT − Interest Expense
Interest expense = cost of servicing debt. Raksha's restaurant loan at 12% on ₹15L = ₹1.8L/year interest cost.
A company with lots of debt pays lots of interest, reducing PBT. This is why high-debt companies with thin margins are dangerous, even a small revenue drop can make interest payments exceed operating profit.
Interest Coverage Ratio = EBIT ÷ Interest Expense. This should be at least 2–3× for comfort. Below 1 means the company can't cover its interest from operating profit, a serious red flag.
PAT: The Bottom Line
PAT (Profit After Tax) = PBT − Income Tax
This is the final profit, what remains after all costs, all interest, all taxes. Also called "Net Profit."
Net Profit Margin = PAT ÷ Revenue × 100
This is the ratio most people cite when comparing companies.
| Profit Level | Formula | What It Excludes | Best Used For |
|---|---|---|---|
| Gross Profit | Revenue − COGS | Overheads, interest, tax | Pricing power and production efficiency |
| EBITDA | Gross Profit − Opex | Interest, tax, depreciation | Operating efficiency across companies |
| EBIT | EBITDA − Depreciation | Interest, tax | True operating profit including asset cost |
| PBT | EBIT − Interest | Tax only | Pre-tax profitability with debt costs factored in |
| PAT | PBT − Tax | Nothing, this is the final profit | Shareholder returns, EPS calculation |
Earnings Per Share (EPS)
EPS = PAT ÷ Total Number of Shares Outstanding
If a company earns ₹200 crore in PAT and has 10 crore shares, EPS = ₹20 per share.
EPS is what the P/E ratio divides the share price by. Rising EPS over time is what drives long-term stock returns. A company that doubles its EPS in 5 years, if the P/E stays constant, doubles its stock price.
Some companies have options, warrants, or convertible bonds that could turn into shares later (increasing the share count). "Diluted EPS" accounts for these potential new shares. It's always equal to or lower than basic EPS. Always use diluted EPS for comparison, it's the more conservative and honest number.
Common P&L Red Flags
If a company's revenue grows 20% but net profit grows 5%, or falls, the margin is compressing. This can happen when raw material costs spike, when the company buys market share through discounting, or when fixed costs are growing faster than revenue. Short-term margin compression can be recoverable. Multi-year compression usually means structural problems.
- One-time gains inflating profit: A company selling a property to boost annual profit. Check "exceptional items" in the P&L: these should be excluded from trend analysis.
- Deferred revenue recognition: Revenue booked today that should be spread over future periods.
- Related-party transactions: Revenue from subsidiaries or promoter-linked entities at inflated prices.
- Interest costs jumping: If interest costs grow much faster than revenue, the company is borrowing aggressively: possibly to fund losses.
Annual revenue: ₹480 crore. COGS: ₹192 crore. Gross profit: ₹288 crore (gross margin 60%, higher than her own restaurant because they have proprietary sauces and scale). EBITDA: ₹96 crore (EBITDA margin 20%). Depreciation: ₹22 crore (heavy, lots of company-owned kitchens). EBIT: ₹74 crore. Interest: ₹8 crore. PBT: ₹66 crore. Tax: ₹17 crore. PAT: ₹49 crore (net margin ~10%). Raksha's verdict: margins are decent, debt cost is manageable, and the trend over 3 years shows PAT growing from ₹28 crore to ₹49 crore, 75% growth in 3 years. She's interested.
Key Takeaways
- The P&L shows revenues minus expenses over a period: unlike the balance sheet which is a snapshot
- Gross profit = revenue minus direct production costs. Gross margin reveals pricing power.
- EBITDA = operating profit before financing, tax, and depreciation: best for comparing companies across capital structures
- PAT (net profit) is the bottom line: what shareholders actually earn
- EPS = PAT ÷ shares outstanding: rising EPS over time drives long-term stock returns
- Watch for exceptional items, one-time gains, and interest costs growing faster than revenue
Now combine the balance sheet and P&L understanding to evaluate whether a stock is priced fairly, read Stock Valuation and DCF.
A company's revenue grew 25% last year, but EBITDA grew only 5% and PAT was flat. What does this most likely indicate?
Disclaimer: This article is for educational purposes only and does not constitute personalized financial advice. Investments are subject to market risks. Past performance does not guarantee future returns. Please consult a SEBI-registered investment adviser before making investment decisions.