Understanding Your Profit and Loss Statement
A profit and loss statement (P&L), also called an income statement, shows your business’s income, expenses and profit over a specific period. Learning how to read it helps you track performance, find areas to improve and make informed decisions about pricing, spending and growth.
Key Sections of a Profit and Loss Statement (P&L):
- Revenue: Total income from sales of products or services before expenses.
- Cost of Goods Sold (COGS): Direct costs of producing your product or delivering your service, including materials and direct labor.
- Gross Profit: Revenue minus COGS, showing what you earn before overhead expenses. Example: $15,000 (revenue) - $5,000 (COGS) = $10,000 gross profit.
- Operating Expenses: Indirect costs like rent, utilities, marketing, insurance and payroll that keep your business running. Additional common line items may include software subscriptions, professional fees, office supplies, travel expenses and depreciation on equipment. Example: Rent, wages, utilities, marketing spend and software subscriptions.
- Net Profit: The bottom line after subtracting all expenses from gross profit, showing your business’s actual profitability. Example: $10,000 (gross profit) - $7,000 (operating expenses) = $3,000 net profit.
How to Use Your Profit and Loss Statement (P&L):
- Track trends in revenue and expenses month over month and year over year to spot growth or warning signs.
- Identify areas where expenses are too high and where you can cut or renegotiate costs.
- Monitor your gross and net profit margins to measure efficiency and pricing effectiveness.
- Share with lenders or investors when applying for funding or lines of credit.
- Use it to support tax planning by understanding profitability and potential estimated tax needs.
What a P&L Does Not Capture:
While a P&L is essential for tracking income and expenses, it does not show your business’s cash flow or overall financial position.
- Cash Flow: A P&L records income when earned and expenses when incurred, not when cash is received or paid. For example, you may show a profit while experiencing cash shortages if invoices are unpaid. A cash flow statement helps track when cash enters and leaves your business to monitor liquidity.
- Assets and Liabilities: A P&L does not show what your business owns or owes. Your balance sheet provides a snapshot of your assets (cash, equipment, accounts receivable) and liabilities (loans, accounts payable) to measure your business’s net worth and financial health.
Tips for Reviewing Your Profit and Loss Statement (P&L):
- Review monthly to catch issues early, such as rising expenses or declining sales.
- Compare your results against your business budget to stay accountable.
- Look for trends to guide decisions on pricing, marketing spend or staffing levels.
- Use it to project future cash flow and set realistic goals for growth.
Final Thought:
A profit and loss statement (P&L) is more than a required document; it is a tool for tracking progress, making informed decisions and strengthening your business. Review your P&L regularly, and pair it with your cash flow statement and balance sheet to gain a complete understanding of your business’s financial health.
