How to Read a Profit and Loss (P&L) Statement

To truly elevate your latest business venture and foster growth, there's an important skill you'll need to acquire: learning how to read your P&L statement. Once you understand your P&L statement, you'll have the information you need to make informed business decisions confidently. Even if you have trusted tax professionals in your corner, being equipped to decipher this information ensures you remain in control.

Small business owners, freelancers, and independent contractors who want to understand their numbers should use this guide to learn how to read each line, the formulas behind them, and how to use those numbers to your advantage.

What Is a Profit and Loss Statement?

A P&L statement is a key financial document that reports on the status of your company’s financial health. It’s produced regularly by accountants for owners, entrepreneurs, and investors to make that assessment.

What Does P&L Stand For?

P&L stands for profit and loss, which are the principal factors assessed in a P&L statement. It's also used interchangeably as an income statement, statement of operations, or earnings statement.

Reading a profit and loss statement simply requires looking for your business's net income over time.

How a P&L Statement Compares to Other Financial Statements

A P&L statement reports on your company’s overall revenue and expenses over a certain period of time. Usually monthly, quarterly, or by fiscal year. It is an income statement reporting directly on net profits. A single look at your P&L statement should indicate whether your business is profitable.

There are two other key financial statements your business should regularly use to report and assess your finances:

• Cash flow statement

• Balance sheet

Unlike a P&L, your cash flow statement isn't interested in net income but in the regular flow of cash in and out of the business. A business needs a reserve of cash on hand to make purchases and pay bills. Even with high net profits, a company with poor or inconsistent cash flow will run into trouble when bills are due and find itself without cash on hand to pay.

While P&L and cash flow statements both report on finances over time, a balance sheet is intended to report on a given moment in time. It’s a snapshot of the current chart of accounts.

The balance sheet includes a comprehensive report of the current state of your company’s finances, balancing assets and liabilities. Reading the balance sheet and the snapshot it provides is most helpful when comparing it to previous balance sheets you've generated.

The Building Blocks of a Profit and Loss Statement

A lot of different ingredients go into a P&L statement. The document should give you a full picture of your income over a set period of time. Ensure you’re familiar with the common bookkeeping terms and financial language you’ll find in a P&L report.

Revenue

The top line of the P&L statement should be your total revenue. This is the money you’ve received from all of your sales. How much have you made?

COGS

The next step is the cost of goods sold, or COGS. COGS includes the raw materials and production costs of your products.

Formula:

Ending Inventory - Purchases + Beginning Inventory = COGS

Gross Profit

To find your total gross margin of profits, subtract COGS from your revenue. This is the gross profit you’ve earned through sales.

Formula:

Revenue − COGS = Gross Profit

Operating Expenses

After revenue, the P&L statement reports on your operating expenses organized into various categories. This is where you include all your normal business expenditures outside the costs of the goods themselves.

This includes both direct and indirect costs of operation. Direct costs are the immediate operation costs, like employee wages and the materials associated with COGS. Indirect costs include everything else, from rental costs to utilities and insurance premiums.

Net Operating Income

Your net operating income represents your total income after you’ve taken out your operating expenses. These are your earnings before interest, taxes, depreciation, and amortization.

Formulas:

Gross Profit − Operating Expenses = Net Operating IncomeNet Operating Income + Other Income − Other Expenses = Net Profit Before Taxes

Other Expenses

P&L statements should include other expenses like interest expense, income taxes, depreciation, and amortization, but they should be counted separately. These aren’t operating expenses, but they still have to get paid.

Net Loss or Profit

The bottom line of your P&L statement is the final, most important total. This is your net loss or profit as a business. That means it’s the total revenue minus all of your expenditures.

Formula:

Net Profit Before Taxes − Taxes = Net Profit or Loss

Formulas at a glance

Refer to the following formulas as you read your P&L statement:

• Ending Inventory - Purchases + Beginning Inventory = COGS

• Revenue − COGS = Gross Profit

• Gross Profit − Operating Expenses = Net Operating Income

• Net Operating Income + Other Income − Other Expenses = Net Profit Before Taxes

• Net Profit Before Taxes − Taxes = Net Profit or Loss

Single-Step vs. Multi-Step P&L Statements

A single-step P&L statement determines net income using a basic equation. In contrast, multi-step P&L statements use multiple equations to categorize revenues and expenses, breaking them down into operating and non-operating activities.

Sample P&L Statement

Review this sample P&L statement for a fictitious small services business.

How to Read a P&L Statement Step by Step

A detailed P&L statement may look intimidating at first glance. It's critical to recognize the separate categories. Find the totals at the end of each section before you read through the lists themselves.

1. Start with revenue at the top.

2. Subtract COGS to find gross profit.

3. Subtract operating expenses.

4. Account for other income and expenses.

5. Review the bottom line.

You should be able to find the most essential takeaways at the beginning and the end of the statement. The top line will be your total revenue or sales, and the very bottom line of the P&L statement will be your net income after all of your expenses have been subtracted from profits.

These are the essential sections you will encounter when reading through your P&L statement:

• Gross profits, which will be the total of your revenue minus COGS

• Operating expenses split into separate categories

• Non-operating costs like taxes and interest expenses

• Net profits after subtracting total expenses

Key Financial Ratios to Calculate From Your P&L

Three critical margins must be calculated for your P&L statement. Each reveals a layer of your business's financial health, measuring profitability at various stages of your operations from core production to the bottom line.

Why Reading Your P&L Statement Accurately Matters

What is your P&L statement for if you don’t know how to read it? Your business plan is only as good as the data it’s based on, and the P&L statement is a key source of data for understanding your business. Your P&L is also critical when securing a business loan, attracting investors, filing accurate taxes, and spotting problems early before they become serious.

The bottom line of the P&L statement tells you whether your company is profitable. Once you have a sense of the larger picture, you can go into the details to see where you can trim expenditures or increase profits.

Common Mistakes to Avoid When Reading a P&L Statement

Avoid these common mistakes as you get into a rhythm of regularly reviewing your P&L statements:

• Confusing your business profit with cash on hand.

• Ignoring non-cash items like depreciation and amortization.

• Only reviewing the P&L once annually instead of a monthly or quarterly cadence.

• Mixing personal and business expenses, which distorts your numbers.

Read Your P&L Statement With Confidence

Your P&L statement is a key financial document produced to assess your business's financial health. Knowing how to read yours is critical, but if you feel unsure of what you're reading or overwhelmed while preparing the next one, expert support is available to handle that process for you.

Learn how full-service bookkeeping from 1-800Accountant acts as the foundation for your P&L statement, with its clean data preventing errors while ensuring your revenue, COGS, and operating expenses are accurately calculated to reveal your true net income.

FAQs about P&L Statements

What's the difference between a P&L statement and an income statement?

There is actually no difference, as these two terms refer to the same financial report. Both summarize your business revenues, costs, and expenses over a specific period of time. The only slight variation is that " income statement " is the formal accounting name, while "P&L" is commonly used as casual shorthand.

How often should I review my P&L statement?

You should review your P&L statement at least monthly to stay on top of your business's financial health. More active businesses may even choose to check it weekly to catch cost increases or falling margins quicker. At a bare minimum, you will need to generate and review it quarterly and annually at tax time.

What's a good profit margin for a small business?

A good profit margin generally falls between 7% and 10%, though this varies heavily by industry. High-margin fields like consulting or software can see margins exceeding 20%, while retail and restaurants usually operate around 2% to 5%. Comparing your specific numbers to your industry average is the best way to determine a good profit margin for your small business.

What's the difference between single-step and multi-step P&L statements?

A single-step statement calculates net income using one basic formula of total revenue minus total expenses. A multi-step statement breaks the process into multiple stages, using subtotals like gross profit and operating income for a more granular analysis. Smaller service businesses typically use single-step statements, while larger companies use multi-step versions to evaluate operational efficiency.

How does accrual vs. cash basis accounting affect my P&L?

Cash basis accounting records revenue only when money hits your bank account and expenses when paid. Accrual basis accounting records revenue when earned and expenses when incurred, regardless of cash flow. Accrual accounting usually provides a more accurate picture of a specific reporting period's actual performance.

Do I need a P&L statement to apply for a business loan?

Yes, virtually all lenders will require a recent P&L statement to approve a business loan. Along with tax returns and a balance sheet, it proves your business generates enough revenue to comfortably repay the debt. Lenders frequently request multiple years of statements to assess your financial stability before greenlighting a loan.

What red flags should I look for on my P&L statement?

Look out for rising COGS that outpace your revenue growth, as this indicates shrinking gross margins. Unexpected spikes in overhead or administrative expenses can quickly erode your net profit. In addition to those red flags, always check for inconsistencies or unexplained dips in your month-to-month and year-over-year sales.

How does my P&L connect to my balance sheet and cash flow statement?

Your P&L's net income flows directly into the cash flow statement and updates the retained earnings on your balance sheet. While the P&L measures your profitability, the cash flow statement tracks the actual movement of money in and out of your accounts. The balance sheet then uses these inputs to provide a snapshot of your overall business assets and liabilities at a specific point in time.

Can I create a P&L statement without an accountant?

Yes, you can easily create a P&L statement on your own if you keep organized, up-to-date financial records. Most modern accounting software, such as QuickBooks or Xero, will automatically generate a P&L for you. However, having an accountant or bookkeeper review your statement is highly recommended to ensure it's compliant with applicable tax laws.