Accounting - The P&L
An Income Statement (P&L) depicts the generation of value over time. At its fundamental core, it comprises four main lines.
Revenue (Top Line)
Cost of Goods Sold (COGS)
Operating Expenses (OpEx)
Profit (Bottom Line)
(Operating) Revenue comprises money generated through main business activities including sale of goods or services. For companies that generate income passively, there are other line items outside of the main four where income may come in. Passive income is excluded as it is not a key component of operating revenue.
COGS refers to the costs attributable to the goods and services that are utilized to achieve revenue. This encompasses direct inputs required to create or provide an additional unit of good.
OpEx, commonly referred to as “burn rate”, comprises all additional costs involved in creating a good or service. This includes corporate overhead, rent, and insurance. The burn rate is a fixed cost regardless of output.
After all Revenue and Costs are accounted for, profit is what remains for the Owner. This is the value generated from business activities.
Modern-day analyses will utilize alternative metrics to analyze the health of a business, including Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). This is a false metric as those are pertinent to Cash Flow. Yes, the business is healthier than the bottom line; however, cash in hand is the most important facet at the end of the day.
In 2020, Hertz, the rental car company, went bankrupt. Leading up to the moment, their revenue had grown 10 straight quarters, and EBITDA was up 50% from the year prior. The unaccounted for debt and interest payments overwhelmed them as revenue decreased, and the company had inadequate cash on hand to service debt, forcing bankruptcy.
Simplified accounting tells the same story as complex reports. Value is profit, profit is cash, and a continually cash-flowing company is stable. This mindset will not garner 10-bagger (10x) returns in a year’s time; it will provide stable growth for the long run.