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Reading a profit and loss statement

A P&L answers one question: did the company make money, and where did it go? Every line is a step in that answer.

6 minute read · part of the free minekop guides

The profit and loss statement — the P&L, or income statement — is a list that starts with everything that came in and takes away everything that went out, in a fixed order. The order is the point. Each subtotal answers a different question, and reading them in sequence tells you where the money actually went.

The shape of it

Line	What it is
Revenue	What you sold, at the price you actually charged.
− Cost of sales	What it cost to deliver those sales.
= Gross profit	What is left to pay for everything else.
− Overheads (SG&A)	The cost of running the company.
= Operating profit	Did the actual business work?
+ Other income − other expenses	Interest, currency swings, one-offs.
= Profit before tax	What the tax is calculated on.
− Tax	The state's share.
= Net profit	What the company actually kept.

A worked example

Gross margin is the number to watch

Operating profit gets the attention, but gross margin is the earlier warning. It moves when your pricing slips, when a supplier puts costs up, or when your mix shifts towards a product that earns less.

Track it every month. A margin sliding from 65% to 61% over a year is a serious problem that no single month's report will make obvious.

Remember that a blended margin is total gross profit over total revenue, never the average of the product margins. The PxQ guide works through why.

Profit is an opinion; cash is a fact

This is the thing that catches people out. A P&L is built on accruals: a sale counts in the month you delivered it, not the month you were paid. A cost counts in the month you incurred it, not the month you paid it.

Which means a company can show a healthy profit and have nothing in the bank. Invoice 50,000 in March, get paid in June, pay your staff in March, April and May — profitable and broke at the same time. See the cash flow guide.

Reading one properly

• Read percentages, not just money. Every line as a percentage of revenue. That is how you compare a good month with a big one.
• Compare with something. A single column tells you almost nothing. Put last month, last year and the plan beside it.
• Look for the line that moved. Profit is down 20% — which line did it? Usually one or two, not all of them.
• Beware one-offs. A grant, a legal settlement, a sold van. Strip them out before you conclude anything about the trend.
• Check the split. If two products share the overheads, look at whether the split is fair before you kill the one that looks unprofitable.

Where the balance sheet fits

The P&L covers a stretch of time — a month, a quarter, a year. The balance sheet is the other kind of statement: a photograph of one single day. What the company owns, what it owes, and the difference between them.

• Assets. Cash, money customers owe you, stock on the shelf, equipment, the van.
• Liabilities. Money you owe suppliers, loans, tax due, wages not yet paid.
• Equity. What is left: assets minus liabilities. The money put in, plus every year's profit that was never taken out.

Assets always equal liabilities plus equity. That is not a rule somebody invented to be strict; it is arithmetic. Every pound of value in the business came from somewhere, and the right-hand side is the list of wheres.

The two statements are joined at one point: this year's net profit is added to equity. Make 19,200 and keep it, and equity grows by 19,200. That is the link that makes the balance sheet balance, and it is why a balance sheet that does not balance almost always means a P&L line went missing.

A useful habit: when the P&L looks good, look at the balance sheet next. If profit is up but the money customers owe you is up by more, you have not made money yet. You have made invoices.

Monthly, not yearly

A year-end P&L is a history lesson. A monthly one is a steering wheel. The month you can see a margin slipping is the month you can still do something about it; twelve months later the only option is regret.

It does not have to be perfect. A monthly statement that is roughly right and arrives on the fifth is worth more than a precise one that arrives in March.

What a P&L will not tell you

• Whether you can pay next week's wages. That is cash flow.
• What the company owns and owes. That is the balance sheet.
• Whether a customer is about to leave, or whether the team is exhausted.

The three statements are meant to be read together. The P&L is performance over a period, the balance sheet is a photograph on one day, and the cash flow joins them up by explaining why the bank balance is not the profit.

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