Profit and loss
Reading a full income statement, finding the line that moved profit most, and explaining why it moved.
Key takeaways
- Do not read every line aloud. Rank the lines by how much each one moved profit in money, lead with the biggest, and use each line as a percent of revenue to see what grew out of line with sales.
- In many offices, interviewer-led formats (common at McKinsey) hand you the statement and ask targeted questions in order, while candidate-led formats (common at Bain and BCG) often expect you to ask for the statement yourself and drive to the moving line.
- The strong answer ranks the lines by their effect on profit and turns the mover into a focused next step.
What this case type is and when it shows up
A profit and loss (P&L) case gives you the lines of an income statement, often as a table for two or more years, and asks you to explain what happened. It is close to a profitability case, but the data arrives as connected lines rather than as an open question, so the skill is reading the statement quickly and finding the line that matters.
The underlying theory, in plain language
An income statement is a stack of subtractions, read from top to bottom. Revenue is money from sales. Subtract cost of goods sold (COGS), the direct cost of making what you sold, to get gross profit. Subtract operating costs such as salaries, rent, and marketing to get EBITDA (earnings before interest, tax, depreciation, and amortization). Subtract depreciation and amortization (D&A), the yearly accounting charge for using up machines, buildings, and other long-term assets, to get operating profit, also called EBIT (earnings before interest and tax). Subtract interest on debt to get profit before tax, then subtract tax to get net income, the bottom line.
Two ratios do most of the work. Gross margin is gross profit divided by revenue: how much of each sale is left after the direct cost of making it. Operating margin is EBIT divided by revenue: how much is left after running the business. If gross margin falls, look at prices and direct costs. If gross margin holds but operating margin falls, look at operating costs.
EBITDA is popular with investors because it removes financing (interest), tax, and accounting charges (D&A), so it is a rough proxy for the cash operations produce before capital spending, working capital, and tax. Consulting cases focus most on gross profit, EBITDA, and EBIT, because those are the lines management can change directly.
Some industries use different lines. A bank has no cost of goods sold; its main line is net interest income (interest earned on loans minus interest paid on deposits). An insurer watches its combined ratio (claims plus expenses, divided by premiums). If you get one of these, ask the interviewer to explain the lines before you analyze.
What the prompts sound like, from simple to hard
- Simple: here are two years of a statement; which line drove the change in operating profit.
- Medium: gross profit held but operating profit fell; what happened.
- Hard: several lines moved at once for a bank or an insurer; untangle which matters and recommend.
Finding and narrowing the real problem
Key idea
Do not read every line aloud. Rank the lines by how much each one moved profit in money, lead with the biggest, and use each line as a percent of revenue to see what grew out of line with sales. Then split that line into price, volume, and cost per unit.
Frameworks for this type, each as a thinking tool with its limit
- The income-statement walk: Go line by line from revenue down, comparing periods, and note each line's change in money. Limit: It finds where the change is, not why; you still need price, volume, and cost logic to explain it.
- Common-size view: Turn each line into a percent of revenue to see which costs grew faster than sales. Limit: Percentages can make a small line look dramatic and hide a large change in a big line, so always check the change in money too.
Methods for solving this type
- Compare each line across periods, in money and in percent.
- Build a profit bridge: the change in profit equals the change in revenue minus the change in each cost line.
- Lead with the line that moved profit most in money.
- Split that line into price, volume, and cost per unit, asking the interviewer for what you need.
- Tie the finding to a clear next step.
The math patterns it relies on
- Subtraction down the statement
- Gross margin = gross profit / revenue
- Percent change per line across periods
- Profit bridge from one year to the next
| Line | Last year (GBP m) | This year (GBP m) |
|---|---|---|
| Revenue | 200 | 205 |
| Cost of goods sold (COGS) | 120 | 145 |
| Gross profit | 80 | 60 |
| Operating costs (excluding D&A) | 40 | 40 |
| EBITDA | 40 | 20 |
| Depreciation and amortization (D&A) | 10 | 10 |
| Operating profit (EBIT) | 30 | 10 |
| Interest | 6 | 6 |
| Profit before tax | 24 | 4 |
| Tax (25 percent) | 6 | 1 |
| Net income | 18 | 3 |
So-what
Revenue rose by 5, and operating costs, D&A, and interest were flat. Cost of goods sold rose by 25, so the 20 fall in operating profit comes from the cost of making the product, partly offset by slightly higher revenue.
Worked cases
Worked case
Harthmoor: operating profit fell by two thirds
The prompt
Harthmoor, a UK maker of kitchen appliances, shared its income statement for the last two years in GBP millions (see the table above). Explain the fall in operating profit and say where to look next.
Interviewer-led: the interviewer hands you the statement and asks what drove the fall, then where to look next.
Clarifying questions, with the interviewer's answers
- Did selling prices change this year?Answer: No. List prices were flat, so the 2.5 percent revenue rise came from selling about 2.5 percent more units.
- Did the product mix change, for example more of a cheaper model?Answer: No, the mix was stable.
- Is the goal to explain the drop, or also to fix it?Answer: Explain it first, then say where to look next.
A hypothesis to say out loud: Revenue rose slightly and operating costs look flat, so my hypothesis is that the direct cost of making each unit has risen, for example from component prices or factory problems. I will test it with the gross margin and the cost per unit.
The structure
- Rank the lines by their effect on operating profit
- Revenue: up 5 (helps profit)
- Key: COGS: up 25 (hurts profit)
- Units sold
- Key: Cost per unit
- Operating costs and D&A: flat
Working it through
1. Size the drop
Operating profit (EBIT) fell from GBP 30 million to GBP 10 million.
EBIT fall (GBP m):30 - 10 = 202. Build the profit bridge
Revenue rose by 5 and COGS rose by 25; operating costs and D&A did not move. The bridge ties out to the 20 fall.
Change in EBIT (GBP m):(205 - 200) - (145 - 120) = -203. Gross margin, last year
Gross profit of 80 on revenue of 200.
Gross margin last year (%):80 ÷ 200 × 100 = 404. Gross margin, this year
Gross profit of 60 on revenue of 205. The margin fell by about 11 points, which points straight at direct costs.
Gross margin this year (%):60 ÷ 205 × 100 = 29.275. Compare growth rates
Revenue grew 2.5 percent, but COGS grew much faster.
COGS growth (%):(145 - 120) ÷ 120 × 100 = 20.836. Cost per unit
Prices were flat, so units rose about 2.5 percent (from the clarifying question). COGS per unit therefore rose by about 18 percent.
This year's cost per unit vs last year:(145 ÷ 120) ÷ 1.025 = 1.187. Follow it to the bottom line
The same 20 fall passes through interest (flat at 6) to profit before tax, which falls from 24 to 4. After 25 percent tax, net income falls from 18 to 3.
Net income this year (GBP m):(24 - 20) × (1 - 0.25) = 3
The recommendation
I recommend that Harthmoor focus on the cost of making each unit, because it explains the whole GBP 20 million fall in operating profit, from 30 to 10. First, revenue rose by GBP 5 million while operating costs, D&A and interest did not change, so the fall sits in COGS, up GBP 25 million. Second, COGS rose about 21 percent while units rose only 2.5 percent, so cost per unit is up about 18 percent. Third, gross margin fell from 40 percent to about 29 percent. Next, split unit cost into materials, labor and factory overhead.
Risks: A one-time event, such as a factory breakdown, may explain the rise and would call for a different fix; If competitors did not face the same cost rise, a price increase would lose market share.
Next steps: Break unit cost into materials, labor, and factory overhead; Compare unit cost with the two largest competitors.
A strong candidate
Built a profit bridge, led with the line that moved profit most, used gross margin and cost per unit to locate the problem, and named a focused next step.
A weak candidate
Read all eleven lines aloud, said "costs went up," and never found the unit-cost problem.
Worked case
A Brazilian pharmacy chain: revenue up, operating profit down
The prompt
A pharmacy chain in Brazil grew revenue last year, but its operating profit fell by a third. The chief financial officer asks why, and whether it should worry. You lead the case and ask for the lines you need.
Candidate-led: there is no exhibit up front. You ask for the income-statement lines and the store data, and the interviewer gives only what you ask for.
Clarifying questions, with the interviewer's answers
- Which profit line does the client care about?Answer: Operating profit (EBIT), which fell from BRL 90 million to BRL 60 million.
- Did the business change shape this year, for example new stores or an acquisition?Answer: It opened new stores; you can ask for the numbers.
- Are the figures for the whole chain in Brazilian reais, for the calendar year?Answer: Yes, BRL, full years.
A hypothesis to say out loud: A pharmacy chain that is opening stores often carries the costs of new stores before their sales mature. My hypothesis is that gross margin held and operating costs grew faster than revenue because of the new stores. I will test it with a profit bridge.
The structure
- Bridge operating profit line by line, then explain the line that moved
- Revenue and gross profit: did gross margin hold?
- Key: Operating costs: growing faster than revenue?
- Old stores
- Key: New stores still ramping up
- Depreciation from new store fit-outs
Working it through
1. Size the fall
Candidate: "Can I see revenue, gross margin, operating costs, and D&A for both years?" Interviewer: "Revenue went from BRL 1,200 million to BRL 1,320 million. Gross margin was 30 percent both years. Operating costs excluding D&A went from 240 to 300, and D&A from 30 to 36." Candidate: "So EBIT fell from 90 to 60."
EBIT fall (BRL m):(1,200 × 0.3 - 240 - 30) - (1,320 × 0.3 - 300 - 36) = 302. Revenue growth
Candidate: "Revenue grew 10 percent, so this is not a demand problem at the chain level."
Revenue growth (%):(1,320 - 1,200) ÷ 1,200 × 100 = 103. Gross profit
With gross margin flat at 30 percent, gross profit grew with revenue.
Gross profit rise (BRL m):1,320 × 0.3 - 1,200 × 0.3 = 364. Profit bridge
Candidate: "Gross profit added 36, operating costs took away 60, and D&A took away 6. That ties out to the 30 fall." Interviewer: "Good. So which line do you go after?" Candidate: "Operating costs, the biggest mover."
Change in EBIT (BRL m):(1,320 × 0.3 - 1,200 × 0.3) - (300 - 240) - (36 - 30) = -305. Operating costs grew faster than revenue
Operating costs grew 25 percent while revenue grew 10 percent, rising from 20 to about 22.7 percent of revenue.
Operating cost growth (%):(300 - 240) ÷ 240 × 100 = 256. Look per store
Candidate: "How many stores did the chain run in each year?" Interviewer: "400 last year and 480 this year." Candidate: "Then operating cost per store rose only from 0.6 to about 0.63 million, but revenue per store fell from 3.0 to 2.75 million. The 80 new stores carry full costs but do not yet sell like mature stores."
Revenue per store this year (BRL m):1,320 ÷ 480 = 2.757. Test the ramp-up
Candidate: "Do new stores usually reach the old-store average?" Interviewer: "In about three years, yes, about BRL 3 million each." Candidate: "At 480 stores and BRL 3 million each, with today's costs, EBIT would be about 96, above last year's 90."
EBIT with all stores at mature sales (BRL m):480 × 3 × 0.3 - 300 - 36 = 96
The recommendation
Operating profit fell by BRL 30 million, from 90 to 60, because the chain is paying for 80 new stores before their sales mature, not because the business got weaker. First, revenue grew 10 percent and gross margin held at 30 percent, so prices and buying costs are fine. Second, operating costs grew 25 percent, and about four fifths of that rise comes from the 80 extra stores (80 stores at about BRL 0.6 million each is about BRL 48 million of the BRL 60 million rise): cost per store rose only about 4 percent, while revenue per store fell from BRL 3.0 million to 2.75 million. Third, if the new stores reach the usual BRL 3 million each, EBIT would be about BRL 96 million on today's costs, above last year. The chief financial officer should worry only if the new stores ramp more slowly than earlier openings did, so the next step is to track them as a separate group.
Risks: The new stores may be in weaker locations and never reach BRL 3 million each; Rents and wages may keep rising, so costs do not stay at today's level.
Next steps: Build a separate income statement for stores opened this year and compare their first-year sales with earlier openings; Hold further openings until this group shows a normal ramp-up.
A strong candidate
Asked for the lines in a useful order, built a bridge that tied out, found operating costs as the mover, and asked for store counts to show that new stores, not weak demand, explain the fall.
A weak candidate
Saw revenue up and profit down, said "costs are out of control," and proposed cutting staff in every store, which would hurt the mature stores that are doing well.
Prompt: "Operating profit dropped. Here is the statement."
Weaker answer
Reads every line in order and concludes that "costs went up and revenue was flat," with no driver and no next step.
Stronger answer
Scans, then says: "Revenue rose 5 and operating costs were flat. The whole problem is COGS, up 25, so gross margin fell from 40 to about 29 percent. With flat prices, unit cost is up about 18 percent. Let me split unit cost next."
Why the stronger answer wins: The strong answer ranks the lines by their effect on profit and turns the mover into a focused next step. The weak one describes the table without finding the driver.
Common mistakes, traps, and curveballs
- Reading every line aloud without finding the mover
- Ranking lines by percent change alone, so a small line that doubled distracts from a large line that rose 20 percent
- Confusing gross profit, EBITDA, EBIT, and net income
- Stopping at the moving line without explaining why it moved
In many offices, interviewer-led formats (common at McKinsey) hand you the statement and ask targeted questions in order, while candidate-led formats (common at Bain and BCG) often expect you to ask for the statement yourself and drive to the moving line. Formats differ by office and change over time, so check the current process for your target office.
Practice
Gross profit is 60, operating costs excluding D&A are 40, and D&A is 10. What is operating profit (EBIT)?
Revenue is 205 and COGS is 145. What is the gross margin, in percent?
A South African car insurer earns ZAR 500 million of premiums in a year, pays ZAR 330 million in claims, and has ZAR 150 million of expenses. What is its combined ratio, in percent?
Revenue rose 2 percent and gross margin held steady, but operating profit fell sharply. Where do you look first?
Gross margin fell from 40 to 35 percent, while operating costs stayed at the same share of revenue. Where do you look first?
Operating profit fell by 20. Interest did not change and tax is 25 percent. By how much should net income fall?
Rank lines by their effect on profit in money, then use margins to see which line grew out of line with sales, and split that line into price, volume, and cost per unit.
Sources for this lesson (1)
- Recognized public explanations of case-interview concepts and frameworks
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