How to read the P&L statement of banks and NBFCs?

The profit and loss (P&L) statement offers crucial insights into a business's financial performance. It highlights the income earned, expenses incurred, and profit generated by a business.

The purpose of the P&L statement is common to all businesses-it serves as a crucial gauge for investors and other stakeholders to assess the financial waters of a company. However, the profit and loss transactions are often complex and different for non-financial companies.

So, in this article, we have decoded the various components of the P&L statements of banks and non-banking financial companies (NBFCs) to make it easier for you to assess their financial health.

Money makes money

The role of interest
For banks, the primary business involves accepting deposits from customers and issuing loans to individuals and businesses. They pay interest on the deposits and charge a higher interest on the loans.

Here are two components: (i) interest earned, which is the income banks receive from customers who have taken loans, and (ii) interest expended, which is the cost banks incur as interest paid to depositors.

The difference between interest earned and expended is called net interest income, and it is the primary source of revenue for banks.

NBFCs also operate similarly to banks but with some differences. Unlike banks, NBFCs cannot accept deposits. Instead, they borrow money from other financial institutions and lend it out, earning interest on these loans. The interest they pay on borrowed funds is similar to the interest expended by banks.

Beyond interest: Other income sources
Banks and NBFCs also earn non-interest income from other activities:
Fees and commissions: Banks and NBFCs earn revenue from loan processing, insurance sales and investment management services, among other sources.
Investment income:Income from buying and selling securities or gains from asset sales.

Managing expenses

Operating expenses
In addition to the interest paid to depositors, banks and NBFCs incur operating expenses. These are costs related to the day-to-day operations of the business, such as:
Compensation to employees: These include salaries and benefits to employees and staff.
Administrative expenses: Costs related to branch operations, utilities, and office supplies.
Marketing and advertising:Costs related to promoting services and acquiring new customers.

Provisions and bad debts
In banking, some loans turn bad. This means not all loans are repaid, leading to non-performing assets or NPAs. To deal with such uncertainties, banks and NBFCs set aside money as provisions. These funds are reserved to cover potential losses that may arise from bad loans or NPAs.

While provisions are an expense and reduce profitability, they also show the bank's risk management capability. High provisions indicate that banks are proactive in dealing with such issues.

Net profit

After deducting all the expenses (including taxes) from the total income, we finally arrive at net profit. No matter the industry, maximising profits is necessary for shareholders' wealth creation because it allows for expansion, dividend payout, and buybacks.

Net profit is the key indicator of the financial health of banks and NBFCs, where money itself is the raw material.

Also read:
What is cash flow from operations
What is margin of safety and why do you need it