How to Read Your Profit and Loss Statement

The profit and loss statement (P&L), also called an income statement, is one of the three core financial statements every business uses. It shows whether the business made or lost money over a period of time — usually a month, a quarter, or a year. If you only learn to read one financial statement, this is the one.

This is plain-English starter content. For broader context, see our Learn hub, the business basics overview, and our bookkeeping basics guide.

The basic shape

A P&L is just a stack of numbers in a specific order:

Revenue
- Cost of goods sold (COGS)
= Gross profit
- Operating expenses
= Operating profit
- Other expenses (interest, taxes)
= Net profit

Each line is a category of business activity. Revenue is at the top; net profit ("the bottom line") is at the bottom. Everything in between subtracts from revenue.

Revenue (the top line)

Revenue is the total money your business earned from customers in the period — before any expenses. It is sometimes split into:

• Sales revenue for products sold
• Service revenue for services delivered
• Other revenue for interest, royalties, etc.

For example, a bakery's revenue is the total dollar value of bread, pastries, and coffee sold during the month, regardless of whether each customer paid cash on the spot or on a tab.

Revenue does not include sales tax you collected for the state — that is not your money, it is the state's, and it sits in a separate liability account on your balance sheet until you remit it.

Cost of goods sold (COGS)

Cost of goods sold is the direct cost of producing what you sold during the period. For a product business, that's materials, packaging, and the labor that physically touches the product. For a service business, COGS is the direct cost of delivering the service — often called "cost of services" or "cost of revenue."

What COGS does not include: rent, software, accounting, marketing, and your own admin time. Those are operating expenses, one section down.

Gross profit and gross margin

Gross profit is revenue minus COGS. It tells you how much each dollar of sales contributes after the direct cost of producing the thing. Express it as a percentage of revenue and you get gross margin.

For example, $100,000 in revenue minus $40,000 in COGS = $60,000 gross profit, or 60% gross margin.

Gross margin is one of the most important numbers to watch. If it falls month over month, either prices are dropping or direct costs are rising. Either way, the business has less to cover overhead and profit.

Operating expenses

Operating expenses ("OpEx" or sometimes "SG&A" — selling, general, and administrative) are the costs of running the business beyond the direct cost of the product or service. Common categories:

• Rent, utilities, insurance
• Salaries and payroll taxes for non-production staff
• Software subscriptions
• Marketing and advertising
• Accounting and legal fees
• Office supplies, travel, training

Operating expenses do not vary much when you sell one more unit, which is why they are sometimes called "fixed costs" — though many of them grow as the business grows.

The IRS deducting business expenses page (sometimes called Publication 535 territory) covers what counts as a deductible business expense for tax purposes. The tax view of "expense" and the bookkeeping view often line up but not always.

Operating profit

Operating profit (also called operating income or EBIT — earnings before interest and taxes) is gross profit minus operating expenses. It tells you whether the core business activity makes money before you account for how the business is financed (interest) or what it owes the government (taxes).

This number is a cleaner measure of business performance than net profit, because it strips out one-time financing decisions.

Other expenses

Below operating profit, the P&L typically lists:

• Interest expense on loans
• Taxes (corporate income tax, depending on entity type)
• Depreciation and amortization in some formats (these are non-cash expenses representing the spread of an asset's cost over its useful life)

For a sole proprietor or single-member LLC, federal income tax is not on the business's P&L — it shows up on the owner's personal Form 1040. For an S-corp or partnership, the same general pattern applies. For a C-corp, federal income tax is a P&L line.

This is general info, not tax advice — talk to a CPA about how taxes flow through your specific entity.

Net profit (the bottom line)

Net profit (also called net income or net earnings) is what is left after every expense. It is the bottom line — literally. Express it as a percentage of revenue and you get net margin.

For example, $100,000 in revenue and $90,000 in total expenses = $10,000 net profit, or 10% net margin.

Net margin varies wildly by industry. Software companies often run 20%+; restaurants often run 3% to 6%. Compare to your industry, not a universal number.

A worked example

For example, here is a one-month P&L for a small landscaping business:

Revenue                              $40,000
- Cost of services (crew, fuel, mulch) $18,000
= Gross profit                       $22,000   (55% gross margin)
- Operating expenses
    Rent                              $1,500
    Office salaries                   $4,500
    Insurance                           $800
    Software, phone                     $400
    Marketing                           $600
    Accounting                          $300
    Other                               $400
  Total OpEx                          $8,500
= Operating profit                   $13,500
- Interest on equipment loan           $400
= Net profit                         $13,100   (33% net margin)

This business's gross margin (55%) is healthy enough that operating expenses leave real net profit. If COGS rose to $25,000 next month, gross margin would drop to 38%, gross profit would be $15,000, and after the same $8,500 of OpEx and $400 of interest, net profit would fall to $6,100 — less than half. That is how quickly margin matters.

How often to look at it

Most small business owners review their P&L monthly, with their bookkeeper or accountant. Quarterly is the bare minimum. Looking at it once a year at tax time is too late — by then any problems have been compounding for months.

A useful habit: open the current month's P&L next to the same month last year. Year-over-year comparison catches trends that month-to-month numbers hide.

Common P&L mistakes

• Mixing personal and business spending. Personal lunches in business meals make the P&L lie. Use a separate business account.
• Categorizing inconsistently. If meals goes to "office expenses" one month and "travel" the next, your category trends are useless.
• Skipping owner pay. A sole proprietor's draws are not an expense, but the owner's reasonable wages are real and need to be considered when judging real profitability.
• Confusing revenue with cash collected. On accrual books they are different. See our cash flow vs profit guide.

What the P&L doesn't show

The P&L is one of three financial statements. It tells you about profitability over a period. To see a complete picture you also need:

• The balance sheet, which shows what you own and owe at a point in time
• The cash flow statement, which reconciles profit to actual cash movement

A P&L by itself can hide a cash crisis. Use all three together when making real decisions.

The SBA's manage your finances hub and the IRS small business page both have additional reading. The BEA's industry data is helpful for benchmarking your margins to your industry.

Tax laws and SBA programs change every year — always check the latest at IRS.gov, SBA.gov, and your state's Secretary of State website.