Why Your P&L Isn’t Telling You About Cash? DEBUNKING A COMMON MYTH! – Part 2

“WHY IS THE INTEREST ON A LOAN INCLUDED IN THE Profit & Loss Statements (and forecasts), BUT NOT THE PRINCIPAL REPAYMENT, EVEN THOUGH IT'S CLEARLY A CASH EXPENSE?!”

In my previous post, we explored how, contrary to common belief, the P&L isn’t about “PROFIT” but rather about “PROFITABILITY”, or, to put it more clearly, it’s not about Cash, but about Costs!

As explained, this is why, counterintuitively, the cost of assets used over multiple years is depreciated, or amortized, with the expense included in the P&L to accurately reflect the proportional cost impacting each specific period.

The second aspect of the P&L that many people find confusing is: “Why is the interest on a loan included in the P&L, but not the principal repayment, even though it’s clearly a cash expense?!”

The answer lies in the purpose of the P&L: it’s designed to capture the costs associated with generating income, not to track cash expenditures. Here’s an illustration to clarify this purpose:

Imagine a company leases a car - a common scenario. The leasing cost appears in the P&L because using the car contributes to generating income. 

Whether the car is worth $50,000 or $100,000 is irrelevant here since the company doesn't “own“ the car. Instead, the expense shown in the P&L is simply the leasing cost, reflecting the cost of usage rather than ownership.

This logic feels straightforward, right?

Now, think of a loan in a similar way. The loan’s principal amount does not contribute directly to income generation, just as the car’s value doesn’t. Instead, what matters is the cost of using the funds, represented by the interest, similar to how the leasing cost matters for the car.

Thus, the loan principal is simply money that flows in when the loan is received and flows out when it is repaid. This movement of cash doesn’t directly contribute to generating income - just as the total value of a leased car doesn’t contribute directly to revenue. Only the cost of using these resources (the interest on the loan or the leasing fee for the car) impacts the income generation process. 

The P&L focusing solely on costs tied to the actual use of resources, not the value of the resources themselves, is the reason the principal repayment is not taken into account in the P&L.

Making more sense now?

See? No need to be a genius 🧠 to understand finance when it’s explained simply and clearly.

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