Profit and loss statement explained: how to read a P&L

What a profit and loss statement shows

A profit and loss statement, also called an income statement, summarizes revenue and expenses over a period. It answers whether the business generated an accounting profit, but it does not show the complete cash position or everything the business owns and owes.

The main sections

Revenue is income earned from ordinary operations. Cost of sales contains costs directly associated with delivering those sales. Their difference is gross profit. Operating expenses cover the wider cost of running the business, such as payroll, rent, software and professional fees. After financing costs, taxes and other items, the statement reaches net profit.

Gross margin = (Revenue - Cost of sales) ÷ Revenue

How to analyze a P&L

Compare each line against the prior period, budget and the same period last year. Convert major lines into a percentage of revenue so changes in business scale do not hide changes in efficiency. Investigate both large monetary variances and smaller changes in sensitive ratios such as gross margin.

Profit is not cash

A profitable company can run short of cash when customers pay slowly, inventory grows or debt is repaid. Conversely, a company can report a loss while cash rises after borrowing or an owner contribution. Read the P&L alongside the balance sheet and cash flow statement.

Questions to ask

• Is revenue growth recurring or caused by one large sale?
• Did gross margin change because of price, mix or input costs?
• Which expenses are fixed and which scale with activity?
• Are accruals or one-off items distorting the period?

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