What it means
The statement starts at the top with revenue, which is the money earned from customers. It then subtracts costs in stages, so that you can see how profit builds up at each level.
The bottom line, called net profit, is what remains after every cost and tax has been deducted. A typical layout begins with revenue, subtracts the cost of goods sold to give gross profit, subtracts operating expenses such as salaries, rent and marketing to give operating profit, and then deducts interest and tax.
Each level tells a different story. Gross profit shows how well the company prices and produces, while operating profit shows how well it runs the whole business.
The statement is used by owners, managers, lenders, investors and tax authorities. Managers compare it with budgets to see where spending is off track, and lenders use it to judge whether the business can afford loan repayments.
Investors look at trends in margins over several periods. It follows the accrual basis of accounting, which means revenue and costs are recorded when they are earned or incurred, not when cash moves.
That is why a profit and loss statement can show a profit while the bank balance is falling, and why it should always be read alongside the cash flow statement and balance sheet. Good practice is to compare the statement against the previous period and the budget, and to express each line as a percentage of revenue.
That makes it easy to see whether margins are improving or whether one cost is growing faster than sales. Many businesses prepare a management version of the statement that is more detailed than the one given to outsiders.
It might split revenue by product line, show costs by department and highlight one-off items separately. This helps managers see underlying performance without the noise of unusual events.
In practice
Real-world examples
Example 1
A cafe owner reviews her monthly statement and sees that sales rose by 8% but profit fell. The line showing milk and coffee costs has grown faster than prices. She renegotiates supplier terms and adjusts her menu prices.
Example 2
A software company shows a net loss of $300,000 in its first year, mostly because of spending on development and marketing. Investors look at gross margin of 80% and conclude that the underlying model is sound. They agree to fund the next stage.
Example 3
A bank manager reviews a small manufacturer's loan application and compares three years of statements. Revenue is steady but operating profit has fallen from $200,000 to $120,000. She asks for an explanation of the rising costs before agreeing to lend.
Think of it
Think of a P and L statement like your car dashboard. Your fuel gauge and speedometer do not tell you how to drive, but they give you essential feedback on your journey, warning you if you are burning through fuel too quickly or running low.
Formula
Calculation
Net profit = revenue - cost of goods sold - operating expenses - interest - tax
Suppose a company has revenue of $1,000,000 and cost of goods sold of $600,000, so gross profit = 1,000,000 - 600,000 = $400,000. Operating expenses are $250,000, so operating profit = 400,000 - 250,000 = $150,000. Interest is $20,000, so profit before tax = 150,000 - 20,000 = $130,000. Tax at 20% = 130,000 x 20% = $26,000, so net profit = 130,000 - 26,000 = $104,000, which is a net margin of 104,000 / 1,000,000 = 10.4%.Case study
Seen in the real world
Linden and Rowe Design Studio is a fictional agency created for this illustration. The founders believed they were doing well because the studio was always busy, but they never looked at a profit and loss statement.
When they finally prepared one, they saw revenue of $900,000 but a net profit of only $27,000, a margin of 3%. The statement showed that freelancer costs and unpaid overruns on fixed-price projects were consuming most of the gross profit.
The illustrative outcome was that they began to price projects using the margins in the statement and to review a monthly report against a target of 15%. Within a year, with revenue slightly lower at $850,000, net profit grew to $127,500.
Watch out
Common mistakes
- Assuming profit means cash in the bank, when the statement uses accrual accounting and ignores timing of payments.
- Looking only at the bottom line, when the stages of gross, operating and net profit reveal where problems begin.
- Mixing personal and business spending, which distorts the statement and misleads anyone who relies on it.
Questions
People also ask
What is the difference between a P and L and a balance sheet?
The profit and loss statement shows performance over a period, while the balance sheet shows what the company owns and owes at a single date.
How often should I prepare one?
Most businesses do so monthly for management and annually for statutory and tax purposes.
Is a P and L the same as an income statement?
Yes, the two names describe the same report, with profit and loss more common in smaller businesses and the UK.