The Expense details
In the prior chapter, we examined the revenue a company produces. Now in this chapter, we will examine the expenses featured in the Profit and Loss statement along with any accompanying notes. Expenses are usually sorted according to the cost of the sales process or the nature of the expense. A breakdown ought to be featured in either the P&L statement itself or its associated notes. As you can view from the sample below, most line items have an annotation related to them.
The ‘Cost of materials consumed’ tops the expense list. This refers to the raw material cost required for producing finished goods. As predicted, this is a firm’s largest outlay, with FY14 at Rs.2101 Crs and FY13 at Rs.1760 Crs. Refer to Note number 19 for further information.
It is evident that note 19 describes the materials consumed, which include lead, alloys of lead, separators and other items totalling Rs.2101 Crs.
The ‘Purchases of Stock in Trade’ and the ‘Change in Inventories of finished goods, work-in-process & stock-in-trade’ are both mentioned in the following two line items. Both are referred to in Note 20.
Purchases of stock, or finished goods bought by the company for conducting their business, add up to Rs.211 Crs. I’ll provide further elucidation on this figure soon.
The inventory of finished goods relates to the costs of manufacturing that were incurred in the past yet sold in the current financial year. This amount is Rs.29.2 Crs for FY14.
A negative number reveals that the company manufactured more batteries than it could sell in FY14. To provide an understanding of the costs of sales, expenses resulting from creating these excess items are deducted from current year costs. They will be applied to the “Purchases of Stock in Trade” when they eventually manage to offload these goods.
Note 20 outlines the two figures mentioned above. Here is an extract of it:
The above extract provides straightforward information that is easily comprehended. One should understand the total. However, a thorough analysis of ‘Financial Modeling’ will be required in the next module.
The following item on the expenses list is “Employee Benefits Expense”, consisting of salaries, contributions to pension plans, and other employee-related outlays – a total of Rs.158 Crs for the FY14. To find out more information, please refer to Note 21 in which this expense is detailed.
Next, we can focus on the section “Finance Cost / Finance Charges/ Borrowing Costs”. This consists of interest and other costs an entity pays when obtaining a loan from a bank or private lender. The company’s finance cost for FY14 was Rs.0.7 Crs, which will be discussed further during the balance sheet chapter.
Following the finance cost, “Depreciation and Amortisation” costs amount to Rs. 64.5 Crs. To comprehend the concept of depreciation and amortisation, one must understand the distinction between tangible and intangible assets.
A tangible asset has a physical presence and is financially beneficial to the company. This includes but is not limited to laptops, printers, cars, machinery, plants, and buildings.
An intangible asset can’t be seen, but it still contributes economic value to the organisation, such as through its brand, trademarks, copyrights, patents, franchises, and customer lists.
A tangible or intangible asset needs to be depreciated over its useful life. This time frame is determined by the economic benefit it provides to a company, such as a laptop enduring up to four years. To gain an understanding of depreciation, take for example, the following.
Company X has earned Rs. 150,000/- from its stockbroking business, though they had incurred Rs. 80,000/- to purchase a computer server with an expected economic life of 5 years. When evaluating their overall earning capability, only a net income of Rs. 70,000/- is displayed, which does not represent the company’s true potential.
The asset, purchased this year, can give economic rewards for its useful life. To reflect this cost more accurately, it is wise to use depreciation – meaning the total expense of the asset is divided and documented throughout its lifespan. This avoids having a large sum to pay all at once.
By depreciating the server over the next five years, we are spreading the upfront cost of Rs. 80,000/- each year. After doing this computation, Company X will now show its earnings as Rs. 90,000/- which is Rs. 150,000 minus Rs. 60,000 per annum.
We can use the same technique for non-material assets. In this case, the depreciation equivalent is called amortisation.
Here is an idea to consider – Company X spreads out the cost of obtaining an asset over its lifetime. But the reality is that Rs. 80,000/- was actually paid for the asset. It looks like this expense does not appear in the Profit and Loss account. As an analyst, we must look at the cash flow statement to get a sense of the actual movements in cash. This concept will be explained further in later chapters.
This is a picture of Note 23 that outlines the depreciation expense.
The final entry on the expense side is a massive Rs.434.6 Crs labeled ‘other expenses’ and warrants closer inspection.
It is clear from the note that apart from manufacturing, selling, and administrative expenses, other costs are included as well. The breakdown of these expenses can be seen in the document; as an example, ARBL spent Rs.27.5 Crs on adverts and marketing efforts.
Totalling the expenditures detailed in the P&L, it appears Amara Raja Batteries has forked out Rs.2941.6 Crs.
— The Profit before tax
Net operating income is the figure calculated after subtracting operating expenses from revenue. Looking further on the P&L statement, ARBL has provided their before-tax and nonrecurring earnings.
Put the profit before tax (PBT) is:
Total Revenues – Total Operating Expenses = Profit before Tax (PBT)
= Rs.3482 – Rs.2941.6
There appears to be an exceptional item of Rs.3.8 Crs which should be removed. These items occur at unexpected times, and the company does not anticipate further expense of this kind. Thus, it is accounted for separately on the P&L statement.
The profit before tax and extraordinary items can be calculated to be:
= 540.5 – 3.88
= Rs.536.6 Crs
The snapshot below (extract from P&L) displays the Profit Before Tax figure for ARBL.
– Net Profit after tax
After-tax, the net operating profit is defined as its operating profit minus its tax obligations. We are now examining the last component of the P&L statement; the bottom line, also known as the profit after tax.
In the above snapshot, we can observe that to calculate profit after tax (PAT), we need to subtract all applicable taxes from PBT. The corporate tax for this year stands at Rs.158 Crs, and other taxes paid are Rs.169.21 Crs in total. When these amounts are removed from PBT of Rs.536.6 Crs, PAT is computed to be Rs.367.4 Crs.
Hence Net PAT = PBT – Applicable taxes.
The last line of the P&L statement provides basic and diluted earnings per share (EPS). This data is a vital factor in the financial analysis and evaluation of the company directors’ and managers’ performance. At ARBL, each ordinary share has an EPS of Rs.21.51. The calculation for this figure can be seen below.
The company has a total of 17,08,12,500 shares on the market. By dividing their net income figure by that amount, we can calculate the earnings per share. In this case:
Rs.367.4 Crs divided by 17,08,12,500 yields Rs.21.5 per share.
– What can we conclude from this?
Having analysed each line item in the P&L statement, let’s review it as a whole.
Hopefully, the P&L statement should now make more sense. Remember, nearly every item on it will come with an explanatory note. If you’re looking for even more details, simply check these out.
Currently, we understand how to read it, but to comprehend the numbers, we must use financial ratios; this part comes later. The statement is closely linked to the balance sheet and cash flow statement too – we will explore this in due course.