What Is a Profit-and-Loss Letter?

The profit-and-loss statement, also known as the income statement or "P and L," describes income and expense information over a period of time, commonly months, quarters or years. The information on the statement can be used as a budget or forecast function, or it can be used to reflect actual activity from the past. When extraordinary events have occurred or may occur, the income statement is accompanied by a letter describing the events.

Variance Analysis

The profit-and-loss statement includes all of the operating income and expenses a business incurs over a period. Analysts often use it to track actual data against what was budgeted or forecast; the difference between the two is called a variance. When a significant variance occurs, the business must explain why. This explanation is called a variance analysis, and while the educated reader may be able to understand the reasons behind the variance by looking at only a spreadsheet, the layperson may not. As a result, a letter explaining the variance usually accompanies the income statement and variance analysis. The letter should point out the dollar and percentage variances from budget for each applicable line item, and state the reason for each.

Change Analysis

When a budget is produced, the new budget may be altered from the previous year's budget. The analysis that's done as a result of these changes may also require a letter accompanying the statement. For example, if a business is opening or closing a unit, or is launching a new product, the letter should explain the business reasons behind the new numbers. Like the letter accompanying the variance analysis, it should also describe the dollar and percentage changes where applicable.

When You Need a Letter

The income statement on its own means little without prior historical data and a commentary to support it. The commentary allows management the opportunity to communicate with shareholders and employees on the company's financial operations, the direction the company is heading and how it intends to get there from a financial standpoint. While experienced analysts who are familiar with the company and its industry may be able to read between the lines of the income statement, the letter provides the rationale that may not be apparent in the numbers.

Income Statement vs. Balance Sheet

Using only the income statement and its letter as the only means of determining a company's financial health is dangerous, however. The balance sheet, which is a record of the company's finances since its inception as of a selected date, contains additional information. Data regarding capital expenditures, assets, and money that's owed to creditors is listed here, and any serious examination of a company's health must take into account this information. While the profit-and-loss letter is a helpful tool for those wishing to understand the company, it's only one piece of what can be a complex financial puzzle.