How to Read a Profit and Loss Statement, Line by Line
The short answer
A profit and loss statement (P&L, or income statement) shows revenue, the costs of earning it and the profit left over for a period. Read it top to bottom: revenue, minus cost of goods sold gives gross profit; minus operating expenses gives operating profit; minus interest and tax gives net profit. Then turn each line into a percentage of revenue and compare it with last month and last year.
A profit and loss statement can look intimidating, but it is just a story told top to bottom: what came in, what it cost to deliver, what it cost to run the business, and what was left. Once you know the order, you can read any P&L in a couple of minutes.
HARBOR & PINE CAFÉ, OCTOBER
Revenue$48,000
Cost of goods sold−$15,360
Gross profit (68.0%)$32,640
Wages−$17,500
Rent−$6,000
Marketing−$1,200
Utilities and software−$1,400
Depreciation−$900
Operating profit (11.8%)$5,640
Interest−$400
Income tax−$786
Net profit (9.3%)+$4,454
An illustrative month. Percentages are of revenue.
Line by line
Revenue
Everything you billed or sold in the period, also called sales or turnover. On an accrual-basis P&L, revenue counts when the sale is made, not when the money arrives.
Cost of goods sold (COGS)
The direct cost of what you sold: ingredients, stock, packaging, direct labor in some businesses. It rises and falls with sales.
Gross profit
Revenue minus COGS. Gross margin is gross profit ÷ revenue: 68% for the café. It tells you whether the product itself makes money before the overheads.
Operating expenses
The cost of running the business whatever you sell: wages, rent, marketing, utilities, software. Depreciation spreads the cost of equipment over its useful life; it is a real cost but no cash leaves that month.
Operating profit
Gross profit minus operating expenses, often called EBIT (earnings before interest and taxes). Operating margin, 11.8% here, shows how well the whole operation runs. Add back depreciation and amortization and you get EBITDA, a figure lenders and buyers often ask for.
Interest and tax
The cost of borrowing, then income tax. These depend on how the business is financed and where it operates.
Net profit
What is left: $4,454, or a net margin of 9.3%. This is the bottom line people talk about.
The questions to ask every month
- How do the percentages compare with last month and the same month last year? Dollar amounts move with sales; percentages show whether the business is getting better at what it does.
- Did gross margin move? A drop usually means supplier prices rose, waste increased or discounts crept in.
- Which expense grew faster than revenue? That is where to look first.
- Are there one-offs? A repair or an annual fee can distort a single month. Note them.
What a P&L does not tell you
A P&L shows profit, not cash. It does not show money customers owe you, stock you bought but have not sold, or loan principal you repaid. A business can show a profit and still run short of cash, which is why the P&L is read alongside a cash flow statement and a balance sheet. Our guides to cash flow and working capital cover the other two.
To see what each sale contributes before overheads, read about gross vs net margin and the break-even point.
Bottom line
Read a P&L from the top: revenue, gross profit, operating profit, net profit. Turn each line into a percentage of revenue, compare it with past periods, and remember that profit and cash are different numbers.
Common questions
What is the difference between a P&L and a cash flow statement?
A P&L shows revenue and expenses when they are earned or incurred; a cash flow statement shows when money actually moves. Unpaid invoices, stock purchases and loan repayments make them differ.
What is EBITDA?
Earnings before interest, taxes, depreciation and amortization: operating profit with depreciation and amortization added back. It is often used to compare businesses with different financing and equipment.
Is a P&L the same as an income statement?
Yes. Profit and loss statement, income statement and statement of operations are different names for the same report.
