How to Read a Profit and Loss Statement: A Small Business Owner's Guide

Every business owner should be able to read a Profit and Loss statement. It’s one of the most important tools for understanding your business’s financial performance.

Yet many owners glance at the bottom line and ignore the rest. They’re missing valuable information that could help them make better decisions.

This guide will teach you to read your P&L like a pro—understanding what every line means and what to look for.

What Is a Profit and Loss Statement?

A Profit and Loss statement (also called an Income Statement or P&L) shows your business’s financial performance over a period of time. It answers the fundamental question: Did we make money?

Unlike a balance sheet (which shows your position at a moment in time), a P&L shows activity over a period—typically a month, quarter, or year.

The basic formula is simple:

Revenue - Expenses = Profit (or Loss)

But the details within that formula reveal much more about how your business is actually performing.

The Structure of a P&L

Every P&L follows the same basic structure:

1. Revenue (Income)

Money earned from your core business activities. This includes:

• Sales revenue: Money from selling products or services
• Service income: Fees for services rendered
• Other income: Interest, rental income, etc.

What to look for:

• Is revenue growing, stable, or declining?
• What’s the mix between product and service revenue?
• Are there any unusual one-time items?

2. Cost of Goods Sold (COGS)

Direct costs to produce what you sell:

• Materials: Raw materials for products
• Direct labor: Wages for production workers
• Subcontractors: Outside help on client deliverables
• Manufacturing overhead: Direct production costs

For service businesses, COGS might include:

• Direct labor costs
• Subcontractor fees
• Project-specific materials

What to look for:

• Is COGS growing faster than revenue?
• What percentage of revenue goes to COGS?
• Are any cost categories out of line?

3. Gross Profit

Gross Profit = Revenue - COGS

This is what’s left after paying for what you sell. It’s the money available to cover operating expenses and generate net profit.

What to look for:

• Gross profit margin percentage (Gross Profit ÷ Revenue)
• Trend over time
• Comparison to industry benchmarks

4. Operating Expenses

All the costs of running your business that aren’t directly tied to production:

• Payroll and benefits: Non-production staff
• Rent and utilities: Facility costs
• Marketing and advertising: Customer acquisition
• Insurance: Business coverage
• Professional services: Accounting, legal, consulting
• Office supplies and equipment: General business needs
• Technology: Software, systems, IT
• Travel and entertainment: Business travel, client meals
• Depreciation and amortization: Asset value allocation

What to look for:

• Which categories are largest?
• What’s growing fastest?
• Are any categories surprisingly high or low?
• What percentage of revenue goes to operating expenses?

5. Operating Income

Operating Income = Gross Profit - Operating Expenses

Also called Operating Profit or EBIT (Earnings Before Interest and Taxes). This shows profit from core business operations.

What to look for:

• Is operating income positive?
• What’s the operating margin (Operating Income ÷ Revenue)?
• How does it compare to previous periods?

6. Other Income and Expenses

Non-operating items:

• Interest income: Earnings on cash
• Interest expense: Cost of debt
• Gains or losses on sales: Asset dispositions
• Other non-operating items: One-time or unusual items

7. Net Income (Profit)

Net Income = Operating Income + Other Income - Other Expenses - Taxes

The bottom line. What’s left after everything else. This is your actual profit (or loss).

What to look for:

• Is net income positive?
• What’s the net profit margin (Net Income ÷ Revenue)?
• How much came from operations vs. other sources?

Sample P&L Walkthrough

Let’s look at a sample P&L and analyze it:

	Amount	% of Revenue
Revenue
Service Revenue	$120,000	100%
Cost of Goods Sold
Direct Labor	$36,000	30%
Subcontractors	$12,000	10%
Total COGS	$48,000	40%
Gross Profit	$72,000	60%
Operating Expenses
Salaries - Admin	$24,000	20%
Rent	$12,000	10%
Marketing	$6,000	5%
Insurance	$3,600	3%
Technology	$2,400	2%
Professional Services	$1,800	1.5%
Office Supplies	$1,200	1%
Other Expenses	$2,400	2%
Total Operating Expenses	$53,400	44.5%
Operating Income	$18,600	15.5%
Other Expense
Interest Expense	$1,200	1%
Net Income	$17,400	14.5%

Reading This Statement

Revenue: $120,000 from services. We’d want to compare this to prior periods and understand the trend.

COGS: 40% of revenue goes to direct costs. This is a 60% gross margin—healthy for a service business.

Gross Profit: $72,000 available to cover operations and generate profit.

Operating Expenses: 44.5% of revenue. The largest items:

• Salaries (20%) - expected for professional services
• Rent (10%) - could be worth reviewing
• Marketing (5%) - is this enough to grow?

Operating Income: 15.5% margin. This is the core business profitability—strong performance.

Net Income: 14.5% after interest. The business is profitable.

Key P&L Ratios

Calculate these ratios monthly to track performance:

Gross Profit Margin

Gross Profit ÷ Revenue × 100

What percentage of each revenue dollar remains after direct costs?

Industry	Typical Range
Retail	25-50%
Manufacturing	25-35%
Professional Services	50-80%
SaaS	70-90%
Restaurants	55-65%

Operating Expense Ratio

Operating Expenses ÷ Revenue × 100

What percentage of revenue goes to running the business?

Lower is generally better, but too low might mean underinvesting in growth.

Net Profit Margin

Net Income ÷ Revenue × 100

What percentage of each revenue dollar becomes actual profit?

Business Type	Healthy Range
Most small businesses	5-15%
High-volume, low-margin	1-5%
Premium services	15-25%

Labor Cost Ratio

Total Labor Costs ÷ Revenue × 100

For labor-intensive businesses, this is often the largest cost category. Track it closely.

What to Look For Each Month

When reviewing your P&L, ask these questions:

Revenue Analysis

1. Trend: Is revenue growing, stable, or declining compared to prior months?
2. Seasonality: How does this month compare to the same month last year?
3. Mix: Has the mix of revenue sources changed?
4. One-time items: Are there any unusual items affecting the number?

Cost Analysis

1. COGS trend: Is COGS growing in line with revenue?
2. Margin preservation: Is gross profit margin stable?
3. Expense categories: Any categories significantly higher than usual?
4. New expenses: Any new line items that appeared?

Profitability Analysis

1. Operating income: Is the core business profitable?
2. Net income: Is overall profit acceptable?
3. Margin trends: Are margins improving or declining?
4. Sustainability: Can this performance continue?

Red Flags to Watch

• Revenue down, expenses stable: Means margins are compressing
• COGS growing faster than revenue: Pricing or efficiency problems
• New expense categories appearing: Scope creep on spending
• Operating income negative: Core business isn’t working
• One expense category spiking: Investigate immediately

Comparing Periods

The most valuable P&L analysis compares across time:

Month-over-Month

• What changed from last month?
• Are changes explainable?
• Is this month an anomaly or a trend?

Year-over-Year

• How does this month compare to the same month last year?
• What’s the annual growth rate?
• Are seasonal patterns consistent?

Budget vs. Actual

• How do actual results compare to your plan?
• Where are the variances?
• Do you need to adjust the plan or change behavior?

Common P&L Problems and What They Mean

Problem: Revenue Growing, Profit Flat

Possible causes:

• Expenses growing with revenue (scaling inefficiently)
• Price erosion (charging less per unit)
• Mix shift (selling lower-margin products)

Action: Analyze gross margin and expense categories

Problem: Gross Margin Declining

Possible causes:

• Cost increases not passed to customers
• Product mix shifting to lower-margin items
• Discounting to maintain volume
• Efficiency problems in production

Action: Review pricing, costs, and product mix

Problem: Operating Expenses Growing Faster Than Revenue

Possible causes:

• Adding overhead in anticipation of growth
• Expense creep (adding without scrutiny)
• One-time items that should be excluded
• Inefficiency

Action: Review each category, question every expense

Problem: Profitable on Paper but Cash Poor

The P&L shows profit, but you’re struggling for cash.

Possible causes:

• Accounts receivable growing (customers not paying)
• Inventory building up
• Debt payments (principal doesn’t show on P&L)
• Asset purchases (capitalized, not expensed)

Action: Look at balance sheet and cash flow statement

Customizing Your P&L

The standard P&L is a starting point. Customize it for your business:

Add Useful Categories

• Break out revenue by product line or service type
• Separate expense categories that you want to track
• Add subcategories for major expense areas

Add Percentages

Show each line as a percentage of revenue. This makes comparison easier and highlights proportion issues.

Add Comparisons

Include columns for:

• Prior month
• Same month last year
• Budget
• Variance from budget

Create Different Views

• Monthly detail
• Year-to-date summary
• Trailing twelve months
• By location or department (if applicable)

Connecting P&L to Action

Understanding your P&L should lead to action:

If Gross Margin Is Low

• Review pricing
• Negotiate with suppliers
• Improve production efficiency
• Focus on higher-margin products/services

If Operating Expenses Are High

• Audit each category
• Eliminate waste
• Renegotiate contracts
• Consider what you can cut without impacting revenue

If Revenue Is Declining

• Analyze by customer or product
• Review marketing effectiveness
• Check market conditions
• Talk to customers

If Profit Is Negative

• Identify the cause (revenue problem or cost problem?)
• Take immediate action
• Create a turnaround plan
• Consider professional help

Your P&L Review Routine

Build a habit:

Weekly (5 minutes)

• Glance at revenue to date
• Note any unusual expenses

Monthly (30 minutes)

• Review complete P&L
• Calculate key ratios
• Compare to prior periods
• Identify 2-3 insights or concerns

Quarterly (1-2 hours)

• Deep analysis of trends
• Compare to annual goals
• Adjust plans based on results
• Identify opportunities

Next Steps

Starting today:

1. Pull your P&L for the last three months
2. Calculate key ratios for each month
3. Identify the biggest expense categories and ask if they’re appropriate
4. Look for trends that concern or encourage you
5. Pick one thing to investigate or improve

Your P&L tells the story of your business. Learn to read it, and you’ll make better decisions.

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Want help understanding your financial statements? At Profit Path Books, we don’t just produce reports—we help you understand what they mean and how to act on them. Book a consultation to discuss your business finances.