## Seeing Through a Company’s True Profitability from the P&L Statement—Don’t Be Fooled by Losses

For investors and entrepreneurs, nothing explains the situation better than a clear income statement. **Profit and Loss Statement (P&L), also known as the pre-tax earnings and losses report, is not only a financial department’s working document but also a key reference for investment decisions.**

### Why must every investor understand the P&L?

Many ask: Why bother learning these financial statements? The answer is simple—**a P&L report can directly tell you whether a company is making money or burning cash**.

Through the P&L, you can see:
- Where the company's main revenue comes from
- How well costs are controlled
- Whether it can cover daily expenses and generate profit
- If operational efficiency is improving

This information helps you judge whether a project or company is worth investing in, and also assists entrepreneurs in optimizing their business strategies to avoid unnecessary cost black holes.

### The core logic of the P&L: a simple subtraction

**The fundamental formula is: Total Revenue - Total Expenses = Profit (or Loss)**

It looks simple, but details determine success or failure. Let’s break it down:

**Total Revenue** refers to all cash and non-cash income generated by the company through sales of goods or services. Note that only the core business’s genuine income is counted here.

**Total Expenses** include everything spent to maintain operations—from raw materials, employee wages, to office rent, advertising, etc.

**Profit and Loss** is the difference between the two. Profit > 0 indicates earning money; profit < 0 indicates a loss.

### From simple to complex: multi-level profit analysis of the P&L

A real P&L doesn’t just give a final answer but breaks down profit layer by layer, allowing you to see the efficiency at each stage:

**Gross Profit = Revenue - Cost**

This reflects the company's pricing ability and production efficiency. The higher the gross profit, the better the company controls costs.

**Operating Profit = Gross Profit - Operating Expenses**

This truly reflects whether the core business is profitable. Regardless of financing, the operating profit directly indicates how good the business is.

**Earnings Before Tax (EBT) = Operating Profit - Financial Expenses**

Includes interest and other financial factors but before taxes.

**Net Profit = EBT - Taxes**

This is the actual profit available to the company and the number investors care most about.

### There are two common formats of P&L—you need to recognize both

**Report Format P&L**: arranged vertically in order of Revenue → Expenses → Net Profit, like a business summary. The advantage is clear logic; the downside is it may overlook details.

**Account Format P&L**: presented in a table with expenses on the left, revenue on the right, and net profit in the middle. This format is more conducive to comparison and spotting anomalies.

Both formats convey the same information; choosing one mainly depends on personal preference.

### How to understand a P&L?

**Step 1: Clarify the time period**

Are you looking at a monthly, quarterly, or annual report? Different periods reveal different issues. A monthly loss might be minor, but if losses persist throughout the year, it’s a warning sign.

**Step 2: Benchmark revenue and expenses**

Don’t just look at the final profit number; examine the relationship between revenue and expenses. Revenue growth with faster expense growth? That’s overdrawing future potential. Revenue decline with decreasing expenses? That could be proactive adjustment or a sign of decline.

**Step 3: Analyze revenue composition**

A healthy company doesn’t overly rely on one source of income. If 95% of revenue comes from a single customer or product, the risk is high. Diversified income streams help resist market risks.

**Step 4: Examine expense structure**

See where the money is going. Is employee cost too high? Are marketing expenses out of control? Is R&D underfunded? These issues can be spotted from the P&L.

### Common pitfalls in P&L, investors should beware

- **Focusing only on profit, ignoring cash**: Good book profit doesn’t mean sufficient cash. A company might be profitable on paper but have piled-up accounts receivable and cash flow issues.

- **Ignoring one-time income**: Some companies’ profits are inflated by one-off gains. Removing these might reveal a loss. Learn to identify “real profit.”

- **Deceived by cost-cutting**: Short-term improvements through layoffs or R&D cuts may look good on the P&L but cause long-term harm.

- **Incomparable across different periods**: Comparing quarterly data with annual data is meaningless. Use year-over-year or quarter-over-quarter comparisons, but avoid random comparisons.

### Summary: P&L is the starting point, not the end

A P&L report can tell many stories, but it’s far from enough. **When making investment decisions, never rely solely on the income statement**; also review the balance sheet (to understand true assets and liabilities), cash flow statement (to see real cash situation), and qualitative factors like industry outlook, management team, and competitive advantages.

The P&L is just one window into a company’s health. Learning to read it can help you avoid many pitfalls; but treating it as the only reference can lead to investment traps. **The ideal investment decision involves multi-dimensional analysis rather than blindly chasing the shiny performance of any single indicator.**