How to Read a Profit and Loss Statement
Revenue at the top, net income at the bottom, and six lines in between that decide whether you had a good month. Here is what each section is telling you to do about it.
Most owners read a P&L the way you read a scoreboard: they skip to the bottom number and feel a feeling about it. That number is the least useful thing on the page. The story is in the four lines above it.
The short answer
How do I read my profit and loss statement?
Read it in four stops, top to bottom: revenue (did we sell enough?), gross profit (does the work itself make money?), operating expenses (what does it cost to keep the doors open?), and net income (what is left). Each stop asks a different question, and each has a different fix when the answer is bad.
The four stops
Revenue — did we sell enough?
The top line is the easiest to read and the most over-weighted. Revenue growing means nothing on its own; plenty of businesses have grown themselves into insolvency.Two things worth checking here, neither of which is the total:
- Mix. If revenue is split by service line or product, which line grew? Growth in your lowest-margin line can raise revenue and lower profit at the same time.
- Comparison. Always read revenue against something — last month, the same month last year, or budget. A number with nothing to compare it to is not information.
Gross profit — does the work make money?
Gross profit and gross margin
Gross profit = Revenue − Direct costs · Gross margin % = Gross profit ÷ Revenue
Direct costs are the ones that only exist because you did the work: materials, subcontractors, production labor. This section ignores rent and admin entirely.
This is the most diagnostic number on the statement. It answers a question that has nothing to do with how well you run the office: when you sell your thing, is there money in it?
How to read a moving gross margin
Gross margin should be roughly stable month to month. When it drops several points and stays there, exactly one of four things happened: your prices are too low, your direct costs rose, your mix shifted toward cheaper work, or work is being done that never got billed. Find out which before touching anything else.
Operating expenses — what does the office cost?
Everything below gross profit is the cost of having a business rather than the cost of doing the work: rent, insurance, admin salaries, software, marketing, professional fees.Read this section as a percentage of revenue rather than in dollars. Overhead dollars almost always rise as you grow; what matters is whether they rise faster than revenue. A business at 32% overhead in January and 41% in June has a problem the dollar figures will not show you.
| | January | June | | --- | --- | --- | | Revenue | $120,000 | $186,000 | | Overhead | $38,400 | $76,300 | | Overhead % of revenue | 32% | 41% | | Net income | $12,600 | $8,900 |
June was the bigger month by a wide margin and made less money. Nothing on the revenue line tells you that; the percentage does.
Net income — what is actually left?
The bottom line, with two caveats that trip up nearly everyone:Net income is not your bank balance
Loan principal payments, owner draws, equipment purchases and tax payments all move cash without touching the P&L. Meanwhile depreciation reduces net income without moving any cash at all. Profit and cash are different questions with different statements.
Second: for an owner-operated business, net income is only meaningful once you have accounted for your own pay. If you draw rather than take a salary, your labor is not in the expenses, and the profit is overstated by whatever you would have to pay someone to replace you.
A monthly reading routine
- Run the P&L for last month with a comparison column — prior month and same month last year
- Read gross margin percent first, before any dollar figure
- If gross margin moved more than two points, stop and find out which of the four causes it was
- Read overhead as a percent of revenue, not in dollars
- Check the three largest expense lines for anything that does not belong there
- Write down one decision the report changed — if there is none, you did not read it closely enough
What to remember
- 01Read the P&L in four stops; each asks a different question with a different fix.
- 02Gross margin is the most diagnostic number on the page — it says whether the work itself makes money.
- 03Read overhead as a percentage of revenue, because dollars always rise with growth.
- 04Net income is not cash, and it overstates profit if the owner's own labor is not in the expenses.
Common questions
- What is the difference between gross profit and net profit?
- Gross profit is revenue minus the direct costs of doing the work. It tells you whether the work itself makes money. Net profit is what remains after overhead, and it tells you whether the business as a whole makes money. You can have a healthy gross profit and still lose money if overhead is too large.
- How often should I look at my P&L?
- Monthly, within about two weeks of the month closing. Quarterly is too slow to change anything, and daily is noise. A monthly rhythm gives you eleven chances a year to correct course.
- Why doesn't my P&L match my bank account?
- It is not supposed to. A P&L on accrual basis counts income when earned and expenses when incurred, while your bank shows only cash that has moved. Loan payments, owner draws and equipment purchases also move cash without appearing on the P&L.