What it means
The P&L is a summary of trading activity between two dates. It starts with the revenue earned from selling goods or services, deducts the direct cost of those sales to arrive at gross profit, deducts the overheads of running the business to arrive at operating profit, deducts interest and tax, and ends with the net profit that belongs to the owners.
Each subtotal has a purpose: gross profit shows whether the product or service is priced above what it costs to provide; operating profit shows whether the business as a whole is viable; net profit shows what is left after financing the business and paying the government. Management P&Ls, prepared monthly for internal use, are often more detailed than the statutory version.
They may show results by product line, branch, customer segment or project; compare actuals with budget and with the same month last year; and express each line as a percentage of revenue so that margins can be tracked. Many small businesses run entirely on the monthly P&L, and a good one is the most useful management tool they have.
A P&L prepared on a cash basis is a very different and much less informative document than one prepared on the accrual basis, and anyone reading a small business's figures should ask which it is. The P&L has to be read with its companion statements.
It measures profit, not cash: a business can show a profit while its customers have not paid and its bank balance shrinks. It shows a period's activity, not the business's position: a loss-making year in a company with strong reserves is a different matter from the same loss in one with none.
And it depends on accounting judgements about when revenue is earned, how assets are depreciated and what costs are accrued, so two accountants can produce somewhat different P&Ls from the same events. The balance sheet and cash flow statement complete the picture.
In practice
Real-world examples.
Example
A restaurant's weekly P&L shows food cost at 34% of sales against a target of 30%, prompting a review of portion sizes and waste.
Example
A software company's P&L shows a net loss but a gross margin of 78%, which tells investors the product is profitable and the loss is a choice to spend on growth.
Example
A manufacturer's P&L by product line reveals that one line with 15% of revenue produces 40% of gross profit while another with 20% of revenue loses money.
Think of it
“A P&L statement is like your monthly budget review-what money came in, what went out, and whether you ended up ahead or behind.
Formula
Calculation
Gross Profit = Revenue minus Cost of Sales
Operating Profit = Gross Profit minus Operating Expenses
Net Profit = Operating Profit minus Interest minus Tax
Margin (%) = Profit at each level / Revenue x 100%
Worked example. A small consultancy's P&L for the quarter, with budget comparison:
- Revenue: actual $420,000; budget $400,000
- Cost of sales (consultants' salaries and subcontractors): actual $252,000; budget $232,000
- Gross profit: actual $168,000 (40.0%); budget $168,000 (42.0%)
- Office and administration: actual $48,000; budget $45,000
- Sales and marketing: actual $30,000; budget $25,000
- Depreciation: actual $6,000; budget $6,000
- Operating profit: actual $84,000 (20.0%); budget $92,000 (23.0%)
- Interest: actual $4,000; budget $4,000
- Profit before tax: actual $80,000; budget $88,000
- Tax at 25%: actual $20,000; budget $22,000
- Net profit: actual $60,000 (14.3%); budget $66,000 (16.5%)
Reading it: revenue beat budget by 5%, but gross margin fell two points because the extra work was delivered by subcontractors at a higher cost, and marketing overspent by $5,000. The result is $6,000 below budget despite higher sales. The management action is to examine subcontractor rates and the marketing overspend, not to celebrate the revenue.Case study
Seen in the real world.
A family-owned printing firm received a P&L from its accountant once a year, three months after year end. The owners ran the business on the bank balance and a sense of how busy the shop floor was. For two years the annual P&L showed shrinking profit; the owners blamed the market.
A new office manager with bookkeeping experience began producing a monthly P&L with a job-level gross margin analysis. Within three months it showed that the firm's largest customer, which the owners prized for its volume, was being served at a gross margin of 9% against 35% for the rest of the book, because its jobs had been quoted years earlier and never repriced despite paper and ink costs rising 40%.
A price renegotiation, in which the customer accepted a 15% increase rather than move its work, restored the firm's overall margin. The owners' comment was that the annual P&L had been telling them the truth too late to act on it.
Watch out
Common mistakes.
- Reading the bottom line only. The subtotals and margins explain what happened; net profit only says that it did.
- Confusing profit with cash. A profitable P&L does not mean money in the bank.
- Producing the P&L once a year. Monthly figures, compared with budget and prior year, are what allow problems to be fixed while they are small.
Questions
People also ask.
What is the difference between a P&L and an income statement?
None. They are two names for the same statement.
What is the difference between a P&L and a balance sheet?
The P&L shows performance over a period. The balance sheet shows what the business owns and owes at a date.
Should a P&L be prepared on a cash or accrual basis?
Accrual, for any business with credit customers, suppliers, stock or assets. A cash-basis P&L reflects the timing of payments rather than trading performance.
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