How to Read a Profit & Loss Statement (No Accounting Background Required)
- Kayli Robles
- Apr 14
- 6 min read
The Profit & Loss (“P&L”) statement is often the first statement business owners look at as part of their monthly or annual financial reviews. The goal is to monitor financial performance and answer the big question: how much did my business make this period?
This question is open to interpretation, of course: cash received can differ from profit reported. We’ll answer the question of how much cash is made in a future post.
In this article, we’ll focus on how to review the key aspects of the P&L effectively, so it can be used as a practical tool for monitoring financial performance and for making business decisions.
What the Profit & Loss Statement Really Shows
Put simply, the P&L summarizes your business’s financial performance over a period of time. Common reporting periods include monthly or annual P&L statements, but any period can be chosen (for example, quarterly statements could be especially meaningful if your business is seasonal).
The P&L tells you whether the business earned more than it spent by breaking out:
Revenue: money earned from sales or services
Expenses: costs incurred to run the business
Profit or loss: what remains after expenses are subtracted from revenue
Although we tend to think of profit as how much the business made during that period, note that the P&L shows net income (or loss), which is often different from net cash flow.
If revenue exceeds expenses, the business reports a profit.
If expenses exceed revenue, the result is a loss.
It’s important to understand that the P&L’s bottom line is only one aspect of this statement: the end-of-period result. But the relationship between the revenue and expenses reported should also be considered.
Revenue vs Expenses: The Core Relationship
It’s the relationship between revenue and expenses that takes us from understanding the financial result of that period’s business activity to understanding financial performance.
The adage “you must spend money to make money” is relevant here. Whether your business provides products or services, there’s a cost to every dollar made. Understanding those costs and their relationship to revenue is key to understanding a business’s financial operations.
Revenue
At the top of the P&L is revenue, the income your business earns from its normal operating activities. This could reflect fees for services, product sales, or subscriptions.
Whether revenue is trending up or down can reflect the impact of pricing decisions or the volume of services, sales, or subscriptions, but it has limited meaning when examined in isolation.
For example, it’s possible for a business to incur a growing net loss, even with increasing revenue, if its expenses are unsustainably high. It’s an unusual scenario, but not impossible.
You can’t properly assess the financial health and profitability of a business without considering the associated costs.
Expenses
Expenses represent the costs of running the business, and they’re typically grouped into two broad categories:
Direct Costs (Often “Cost of Goods Sold” or “COGS”)
Direct costs, cost of sales, or COGS are the expenses directly tied to delivering your product or service. They increase or decrease with revenue, and the relationship between the two is reflected in your gross margin, discussed below.
The type of direct costs your business incurs depends on what you’re selling, but some examples include payments to subcontractors, the cost of inventory or of materials and production, or shipping costs.
Operating Expenses
General or operating expenses are the broader costs required to run the business itself. Although they can increase or decrease with revenue, they’re indirect costs of running the business. Thus, they have a less immediate relationship to revenue than direct costs.
Operating expenses commonly include things like marketing, software subscriptions, insurance, rent, office expenses, and other administrative costs.
Understanding the difference between these two broad types of expenses can help bring clarity to what drives the business’s profitability.
Gross Profit vs Net Profit
Gross and net profit are perhaps the most important figures reported on the P&L, and they’re often confused with one another. These calculations of profit reflect slightly different aspects of the business.
Gross Profit
Gross profit is typically near the top of your P&L and measures how profitable your core product or service is before operating expenses are considered:
Gross Profit = Revenue – Direct Costs
For example, if your business earns $10,000 in revenue and has $4,000 in direct costs, your gross profit would be $6,000. This is the amount available to cover operating expenses and contribute to net profit.
This is your first stop when making decisions about:
Product or service pricing and mix
Production or direct input costs, and whether they contribute to a sustainable margin
Operating costs, and whether the business generates enough margin to support them
A healthy gross profit gives the business room to cover operating expenses while remaining profitable, based on typical sales volume.
Net Profit
Net profit is often where our eyes fall first because it’s the final result of the P&L, indicating how much the business made that period.
It’s calculated after all expenses (both direct and operating) have been deducted from revenue:
Net Profit = Revenue – All Expenses
Following the previous example, if your gross profit was $6,000 and you have an additional $4,000 of operating expenses, your net profit is $2,000.
Net profit shows whether the business is financially sustainable overall, and how much is available to be deployed toward:
Paying the owner
Building reserves
Reinvesting for growth
Safeguarding against slower periods
If the business incurs a net loss, then business owners can start looking at where the business’s financial health can be improved, beginning with gross profit and then drilling down into the most significant operating expenses.
Of course, gross and net profit shouldn’t be examined exclusively or in isolation.
How to Read the P&L: What Small Business Owners Should Focus On
A P&L statement can include many individual line items (but preferably only as many as keep the P&L useful). The goal of a monthly review isn’t to analyze each one, but to get an overall assessment of performance that period and let those higher-level areas indicate where more detailed attention is needed.
You can read your P&L effectively by focusing on four key areas:
Look for revenue trends: Is income increasing, declining, or staying consistent over time? Compare revenue to the previous months or periods to identify any trends.
Review gross margin: Is your gross margin % (gross profit/revenue) consistent month-to-month? If not, consider whether this might have been caused by product or service mix, or increasing direct costs.
Review major expense categories: Are there any costs that stand out or appear to be growing faster than expected? Compare your expenses to those of prior months or periods to spot any unusual changes.
Review overall profitability: Does the net result align with how the business felt during that period? If not, a closer look at revenue versus expenses might be warranted.
This review can usually be done quickly, and completing it monthly will help develop a sense of what’s normal for your business, which can support you in identifying any trouble areas more quickly in the future.
A good place to end your review is to consider whether the financial results seem to make sense based on what actually happened in the business during that period. If not, there are several possibilities to consider:
Net profit doesn’t always equate to cash in the bank, so it’s worth exploring whether this explains the difference.
Were there any operational activities that may have a unique impact on the financial results? For example, activities such as training new hires or additional marketing efforts can have delayed impacts on your gross profit.
Is it possible that there are misclassifications or other errors in the books? This is where a closer and more detailed look at the line items of the P&L may be necessary.
The Profit & Loss Statement as a Decision-Making Tool
Financial statements are historical. Their usefulness as a decision-making tool comes from interpreting that historical data to help guide the future of the business.
Consistent monthly reviews build your understanding of business patterns, trends, and the cause-and-effect of historic decisions made, all through a financial lens. This helps you project business performance into the future, whether by:
Repeating the activities that generate the best results, or
Understanding how much risk the business can take on while experimenting with new directions.
Financial familiarity supports confident business decision-making.
Building that familiarity can require diving deeply into the books, which often requires more time and effort than business owners have available. When you identify an inconsistency or unexpected financial result in your P&L, a deeper conversation with your bookkeeper can save time and provide valuable context.
If your financial reports still feel unclear, or you’d like a second set of eyes on your books, I’m always happy to help. Clean, well-organized financials make these reports far easier to interpret and act on.
Feel free to schedule a free evaluation of your books, and I’d be happy to help you make your numbers more meaningful.
