What a profit and loss statement actually tells you

Most business owners get a profit and loss statement every month and look at one number on it. That number matters, but it is the least informative line on the page. The statement is built in layers, and each layer answers a different question.

First: it covers a period, not a moment

A profit and loss statement, also called an income statement, describes a stretch of time: a month, a quarter, a year. It tells you what happened during that period. It does not tell you what the business owns or owes right now; that is the balance sheet’s job. Keeping the two apart avoids the most common confusion, which is why a profitable month can still leave the bank account thin.

Revenue: what came in

The top line is sales, or revenue: the value of the work the business did in the period. Depending on how the books are kept, that may mean invoices raised during the period, or cash actually received. Which method the business uses matters for reading the rest of the statement, and it is worth knowing which one yours is on.

Cost of sales: what it took to deliver the work

Directly under revenue sit the costs that only exist because the work happened. For a contractor that is materials, subcontractors, and the labour on the job. For a shop it is the goods sold. These are sometimes called cost of goods sold or direct costs.

Gross profit: the first number worth watching

Revenue minus cost of sales is gross profit. It is the money left after the job itself is paid for, and before the business’s overheads. Expressed as a percentage of revenue, it is the gross margin.

This is the line that tells you whether the work is priced correctly. If revenue rises but gross profit does not, the business is doing more work for the same money, which usually means materials are up, labour is up, or jobs are being quoted too low.

Operating expenses: the cost of existing

Below gross profit come the costs the business pays whether or not it did any work that month: rent, insurance, software, phones, vehicles, office wages, advertising, accounting. These are the overheads.

Seen on their own, overheads look like a list of bills. Seen against gross profit, they answer a sharper question: how much gross profit does the business need to generate each month just to cover being open?

Net profit: what was left

Gross profit minus operating expenses is net profit, or net income. This is the number most people look at first. It is the right number to end on, but read in isolation it hides the reasons behind it. A fall in net profit can come from lower sales, thinner margins, or higher overheads, and each of those calls for a different response.

How to actually use it

• Compare, do not just read. This month against last month. This month against the same month last year. The direction of travel is the information.
• Watch gross margin first. It moves before anything else when pricing or costs drift.
• Look for lines that grew faster than revenue. That is where money is leaking.
• Ask why, line by line. A good statement raises questions. A good bookkeeper can answer them.

What it cannot tell you

A profit and loss statement does not show cash in the bank, money customers still owe, money the business still owes, loan balances, or equipment bought. All of those live on the balance sheet. A business can show a healthy profit and be unable to pay its bills, and the reasons are never on this page. That is the subject of its own article.