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Analyze the Profit and Loss account

Learn how to analyze a profit and loss statement (P&L), assess profitability, EBITDA and cash flow, and evaluate a company's financial health and credit risk.
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How to Analyse a Profit and Loss Statement

A practical guide to understanding a customer's revenue, profitability and financial resilience before making a credit decision.

Financial statement analysis is a cornerstone of customer creditworthiness assessment. It combines financial techniques with business judgement: the aim is not to calculate every possible ratio, but to identify the factors that affect a customer's ability to pay its suppliers.

Begin with the income statement (also called the profit and loss statement, or P&L) and the balance sheet. Review their main components and, whenever possible, compare at least three financial years.

Understanding the profit and loss statement

The P&L reports the revenue earned and expenses recognised over an accounting period, usually a financial year. The difference between income and expenses produces a net profit or loss. Unlike the balance sheet, which describes a company's position at a particular date, the P&L measures performance over time.

Profit and loss statement diagram showing revenue, operating expenses, EBIT, interest, tax and net income
Original illustration: the main components of a profit and loss statement.

Analyse the main income statement measures

Intermediate measures help identify where profit is generated or lost. Definitions vary by accounting framework and industry; use consistent definitions when comparing companies or years.

Key profitability measures and their interpretation
Measure Typical calculation or definition What it tells the credit analyst
Gross profit / gross margin Revenue minus cost of goods sold; gross margin is gross profit divided by revenue. Pricing power and direct production or purchasing costs.
Value added Output or sales less externally purchased goods and services, according to the reporting framework. Value created by the business before distribution to employees, government and capital providers.
EBITDA Earnings before interest, taxes, depreciation and amortisation. Operating earnings before financing costs and non-cash depreciation or amortisation; not equivalent to cash flow.
Operating profit (EBIT) Operating income minus operating expenses, including depreciation and amortisation. Profitability of operations after the consumption of fixed assets.
Net finance result Finance income minus finance costs. Impact of debt servicing and other financial items; persistent high costs merit further analysis.
Profit before tax Profit after operating and finance items, before income tax, subject to the reporting framework. Overall earnings before tax.
Non-recurring items Material unusual or non-recurring gains and losses disclosed in the accounts. Whether reported earnings are sustainable. Presentation differs under IFRS and local GAAP.
Net profit or loss Total recognised income minus expenses and tax for the period. Bottom-line performance; retained profits may increase equity, while dividends reduce retained funds.

Investigate large year-on-year changes, margin deterioration, exceptional gains and unusual accounting estimates. An apparently strong net profit can conceal weakening underlying operations; a reported loss can sometimes arise from a one-off charge despite a viable core business.

Cash generation: distinguish earnings from cash flow

A common simplified measure of internal financing capacity starts with net income, adds non-cash depreciation and provision expenses, and subtracts relevant non-cash reversals. However, the precise calculation of cash flow from operations or cash flow available for investment and debt repayment requires additional adjustments, including changes in working capital and, depending on the measure, interest and tax cash flows.

Why it matters: a profitable customer may still face payment difficulties if receivables are collected slowly, inventories build up, or significant debt repayments fall due. Review the cash flow statement where available, alongside the balance sheet and payment behaviour.

  • Assess the sustainability of operating earnings.
  • Examine the cash conversion of profits and changes in working capital.
  • Compare operating cash generation with capital expenditure and debt maturities.
  • Investigate dependence on short-term funding, factoring or extended supplier terms.

Conclusion: use the P&L to inform credit decisions

The income statement reveals a customer's commercial development, profitability and capacity to generate earnings. It is a vital starting point, but it must be interpreted together with the company's financial structure, working capital requirements, liquidity and payment history.

Continue the assessment with the balance sheet analysis tutorial (verify this destination in the CMS before publishing).

Understand and analyze the balance sheet →
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Last comments
R. 11-28-2019
Very useful
A.T. 03-19-2018
Nicely explained
S.M.
This is a very informative article. Properly analyzing your profit and loss statement is vital to business growth.
L.
How calculate the Cash flow: Net income + depreciation
M.B.
Good presentation
H.
Helpful
P.
Really a good work.
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