Understanding Company Profitability: A Deep Dive

Economic Analysis: Understanding Company Profitability

Economic analysis focuses on studying a company's profitability. This section provides information about different types of business results and the various ways profitability is achieved. It indicates whether investments are sound, management is efficient, and provides a snapshot of a company's assets. It reveals whether investments are profitable, identifies problems, and highlights areas of concern. It is based on the study of the profit and loss account.

The Profit and Loss Account

The profit and loss (P&L) account is an accounting document that reflects the results obtained by a company during a given period. While the balance sheet represents the company's assets, the P&L account details the economic activity. Its preparation requires analyzing business income and expenses:

• Income > Expenses = Positive (Profits)
• Income < Expenses = Negative (Losses)

To gain a more granular understanding of company performance, results are classified into categories (Operating, Financial, Extraordinary, and Taxes), as shown in the following table:

1. Operating Income: Operating income, operating expenses.
2. Financial Result: Financial income, financial expenses.
3. Ordinary Activities Result: 1 + 2.
4. Extraordinary Result: Extraordinary loss, extraordinary income, extra expenses.
5. Income Before Taxes: 3 + 4.
6. Profit for the Period: 5 - Taxes.

Let's examine each category in more detail:

1. Operating Income: This stems from the normal business activity (e.g., sales of products, raw material costs, personnel expenses). This is crucial information, often referred to as:
   • EBIT: Earnings Before Interest and Taxes.
   • EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization.
2. Financial Results: These are derived from the company's financial operations (e.g., interest from savings or loans).
3. Extraordinary Result: This includes revenues and expenses incurred outside the normal business activity (e.g., sale of fixed assets or losses from a disaster).
4. Profit for the Year: This represents the overall result of the company's activity and is reflected in the company's balance sheet. A positive result indicates profits, while a negative result indicates losses. The company only pays tax on profits. The tax rate is usually 35%, with some exceptions.

An alternative way of representing the company's results is through the income statement:

Sales Revenue
- Cost of Goods Sold (Opening Stock + Purchases - Closing Stock)
= Gross Profit (Commercial Margin)
- Overhead Expenses
= Operating Result
+ Financial Result (Financial Income - Financial Expenses)
= Result from Ordinary Activities
+ Extraordinary Result (Extraordinary Income - Extraordinary Expenses)
= Profit Before Tax
- Taxes
= Profit for the Year