The profit and loss statement, often shortened to P&L or called an income statement, summarises income and expenses for a period such as a month, quarter or year. It answers a simple question: did the business make money, and where did it come from and go?

The sections, top to bottom

Revenue (income). Sales of products and services for the period. If you sell several things, separate lines for each make the report more useful. Refunds and discounts are often shown as negative income so gross sales and net sales are both visible.

Cost of goods sold. For businesses that sell products, the cost of the items sold during the period. The IRS explains inventory and cost of goods sold in Publication 334. Service businesses may include direct costs such as subcontractors here.

Gross profit. Revenue minus cost of goods sold. Divided by revenue, it gives gross margin, one of the most useful numbers in the report. A falling gross margin usually means prices, supplier costs or discounting have changed.

Operating expenses. The costs of running the business: rent, wages for staff not included in cost of goods sold, software, insurance, marketing, professional fees and so on.

Operating profit. Gross profit minus operating expenses.

Other income and expenses. Items outside normal operations, such as interest paid on loans or interest earned.

Net profit. What is left after everything. This is not the same as cash in the bank, which is why the P&L should be read alongside the balance sheet.

What to look for each month

  • Trends, not single months. Compare with the previous month and the same month last year.
  • Gross margin. Is it steady? A small change can move net profit a lot.
  • Expense lines that jump. A sudden rise may be a real change, a one-off or a posting error.
  • Large "uncategorized" or "miscellaneous" amounts. They make the report less reliable and should be cleared up.

Why profit and cash differ

Profit can be positive while the bank balance falls. Common reasons include customers who have not paid yet, inventory purchases, loan principal repayments and owner withdrawals, none of which appear as expenses on the P&L. The balance sheet and a cash flow view explain the difference.

Cash or accrual basis?

The same transactions can produce different P&Ls depending on whether income and expenses are recorded when cash moves or when they are earned and incurred. The IRS explains both methods in Publication 538. Check which basis your report uses before comparing it with another report.

Key terms

  • Gross margin: gross profit divided by revenue, shown as a percentage.
  • Operating expenses: the regular costs of running the business that are not part of cost of goods sold.
  • Contra-revenue: an account such as refunds or discounts that reduces revenue.
  • Comparative report: a P&L that shows two or more periods side by side so trends are visible.
  • Basis: whether the report is prepared on a cash or accrual basis, which changes when income and expenses appear.

Using the P&L to make decisions

A reliable P&L lets you price work, decide whether you can afford to hire and spot costs that are creeping up. It is only as good as the bookkeeping behind it, which is why we reconcile every account before reports go out. Learn about our bookkeeping services and accounting services.