A profit and loss statement — also called an income statement, or just a P&L — answers one question: over this period, did the business make money? It is the most useful report you have, and most small business owners only look at it when their accountant sends it.
The structure
Every P&L is the same four moves, in order. Everything else is detail.
| Line | Amount | What it is |
|---|---|---|
| Revenue | $48,000 | What you earned from customers. |
| less Cost of goods sold | $18,000 | Costs that only exist because you made the sale. |
| = Gross profit | $30,000 | What is left to run the business with. |
| less Operating expenses | $24,500 | The cost of existing: rent, wages, software, insurance. |
| = Net profit | $5,500 | What the business actually made. |
Revenue: earned, not received
This is the line people misread most often. On an accruals basis, revenue is recognised when you earn it — when you do the work or deliver the goods and issue the invoice — not when the customer pays.
So a $20,000 invoice you issued on 28 June appears in June's revenue even if it is paid in August. Your June P&L looks great and your June bank account does not. That is not an error; it is the report doing its job. The invoice is an asset sitting in accounts receivable on your balance sheet.
On a cash basis, revenue appears when the money arrives. Cash-basis P&Ls are easier to reconcile against your bank but worse at telling you whether a month was actually good, because a slow-paying customer makes a strong month look weak.
Cost of goods sold vs operating expenses
The split matters, and getting it wrong makes your gross margin meaningless.
- Cost of goods sold (COGS, sometimes "cost of sales") is cost that exists *because of a specific sale*. Stock you bought and sold. A subcontractor on a specific job. Materials. Merchant fees on the transaction.
- Operating expenses are the cost of being in business at all, whether you sell anything this month or not. Rent. Your own salary. Accounting software. Insurance. Bookkeeping.
The test is simple: if you sold nothing next month, would this cost disappear? If yes, it is COGS. If you would still pay it, it is an operating expense.
The three numbers worth watching
1. Gross margin percentage
Gross profit divided by revenue. In the example above: $30,000 ÷ $48,000 = 62.5%. This is the most diagnostic number on the report, because it tells you whether the thing you sell is fundamentally profitable, separate from your overheads.
Watch the trend, not the level. A gross margin sliding from 62% to 55% over six months means your pricing has drifted behind your costs — and it will take a while to show up in net profit, by which point you have lost half a year.
2. Net profit percentage
Net profit divided by revenue. $5,500 ÷ $48,000 = 11.5%. This is the whole business in one number. If it is falling while gross margin holds steady, your overheads are growing faster than your revenue.
3. Your break-even revenue
Operating expenses divided by gross margin percentage. $24,500 ÷ 0.625 = $39,200. That is the revenue you need in a month just to cover your overheads. Knowing it changes how you read a quiet month — you stop guessing and start measuring against a line.
Why profit is not cash
This is the thing that sinks otherwise healthy small businesses. A profitable business can run out of money. Several things on a P&L do not move cash, and several cash movements never appear on a P&L at all.
| On the P&L? | Moves cash? | |
|---|---|---|
| An unpaid invoice you issued | Yes, as revenue | No, not yet |
| Depreciation on a vehicle | Yes, as an expense | No — the cash went out when you bought it |
| Buying $10,000 of stock you have not sold | No | Yes, immediately |
| Repaying the principal on a loan | No | Yes |
| Owner drawings | No | Yes |
| GST you collected and owe | No | Held, then out |
So read your P&L next to your cash position, not instead of it. Profit tells you whether the business model works. Cash tells you whether you can pay for it this week. You need both.
A ten-minute monthly routine
- Check the period is complete. A P&L run before the month is reconciled is fiction. Look for uncategorised transactions first.
- Compare to last month and the same month last year. A single month in isolation tells you almost nothing.
- Read gross margin percentage before anything else. If it moved more than a couple of points, find out why before you look at anything else.
- Scan operating expenses for anything new or unusually large. New subscriptions accumulate invisibly.
- Check net profit against your break-even. Above it or below it, and by how much.
- Then look at cash. What is in the bank, what is owed to you, and what you owe — including the GST and super you are holding.
Five things that should stop you
- Gross margin falling for three periods in a row. Your prices are behind your costs.
- Revenue growing while net profit is flat. You are buying growth with overhead.
- A large "suspense", "uncategorised" or "ask my accountant" balance. The report is not finished, so do not trust it yet.
- Owner drawings appearing as an expense in a sole trader's P&L. Drawings are equity — see sole trader vs company bookkeeping.
- A profitable P&L and a shrinking bank balance. Something is consuming cash that the P&L cannot see. Usually stock, receivables, or loan principal.
Common questions
This guide explains general bookkeeping concepts rather than tax law, so it cites no authority. It is general information, not advice for your situation.