Your balance sheet shows where the business stands on a single day. Your profit and loss statement tells the story of how you got there. Learning how to read a profit and loss statement means you can look at any month, quarter, or year and see what came in, what it cost to earn it, and what was left over.
If you’ve already worked through our guide on how to read a balance sheet, think of this as the other half of the picture. The two reports answer different questions, and they’re most useful when you read them together.
What a Profit and Loss Statement Covers
A profit and loss statement (often called a P&L or income statement) covers a period of time. It might be a single month, a quarter, or the year to date.
At its simplest, the report follows one line of logic: revenue, minus the cost of the products you sold, minus the cost of running the business, equals profit.
What it doesn’t show is just as useful to know. The P&L won’t tell you how much cash is in the bank, how much inventory is sitting in the warehouse, or how much you owe on a loan. Those live on the balance sheet.
How to Read a Profit and Loss Statement From the Top Down
Most P&Ls follow the same general order. Reading them from top to bottom is the easiest way to keep your bearings.
Revenue
The top section shows what the business brought in from sales. Depending on how your books are set up, you may see a few lines here:
- Gross sales, before anything is taken out
- Discounts and promotions
- Returns and refunds
- Shipping income charged to customers
- Net sales, which is what’s left after those adjustments
For ecommerce sellers, one detail matters a lot. Marketplaces and payment processors usually pay out after taking their fees. If those payouts are recorded as revenue, your sales look smaller than they really were and your fees seem to disappear. A cleaner P&L records the full sale as revenue and the fees as their own expense.
Cost of Goods Sold
Cost of goods sold (COGS) is what it cost you to acquire or make the products you sold during the period. For a product seller, it often includes the product cost itself and the freight to get inventory to you. Some businesses also include packaging or fulfillment costs here.
There isn’t one perfect setup, but consistency matters. If fulfillment fees are in COGS one month and in operating expenses the next, your comparisons stop making sense.
Gross Profit
Gross profit is revenue minus COGS. It tells you how much each dollar of sales contributes before overhead. If this number is weak, no amount of cost cutting in the office will fully fix it.
Operating Expenses
This is everything it takes to run the business that isn’t tied directly to a specific product. Common lines include:
- Advertising and marketing
- Payroll and contractor costs
- Software and subscriptions
- Rent and utilities
- Merchant and marketplace fees, if you don’t include them in COGS
- Professional fees, insurance, and office costs
Operating Income and Net Income
Subtract operating expenses from gross profit and you get operating income, which is what the core business earned. Below that, you may see other items like interest expense or one-time income. The final line, net income, is the bottom line for the period.
Questions to Ask Every Time You Open It
Reading a P&L gets faster once you have a few go-to questions:
- Did revenue grow, shrink, or hold steady compared with last month?
- Did gross profit move in the same direction as revenue?
- Which expense lines changed the most, and do I know why?
- Is there anything here I don’t recognize?
- Does the bottom line match how the month actually felt?
That last question is more useful than it sounds. If the business felt busy and profitable but the P&L shows a loss, something is either happening in your costs or something is off in the books.
Compare, Don’t Just Read
A single P&L in isolation doesn’t say much. The real value comes from comparison.
Month over month
Lining up the last few months side by side shows trends. A steady rise in ad spend or a slow slide in gross profit is much easier to spot this way.
Year over year
For seasonal sellers, comparing this November with last November is often more honest than comparing November with October.
As a percentage of revenue
Looking at each line as a percentage of sales helps separate growth from inefficiency. If revenue doubled and shipping costs doubled, that’s expected. If shipping went from a small slice of sales to a much larger one, that’s worth a closer look.
Common Reasons a P&L Looks Off
Sometimes the problem isn’t the business. It’s the books. A few things to watch for:
- Inventory purchases recorded as expenses instead of moving through COGS as products sell
- Marketplace or processor deposits recorded as net revenue
- An uncategorized or “ask my accountant” account with a growing balance
- Owner draws or distributions recorded as expenses
- Duplicate transactions from bank feeds and sales channel integrations overlapping
- Loan payments recorded entirely as expenses, instead of separating principal from interest
If you’re seeing a loss and can’t figure out why, our post on why your business isn’t making a profit and what the numbers are really showing you is a good next step. Shopify sellers may also find our post on the financial blind spots in Shopify bookkeeping helpful, since many of those blind spots show up first on the P&L.
Reading the P&L Alongside the Balance Sheet
Profit and cash aren’t the same thing, and the gap between them usually shows up when you read both reports.
A month can be profitable on the P&L while the bank account shrinks. Maybe you bought a big round of inventory, paid down loan principal, or took a distribution. None of those show up as expenses on the P&L, but all of them use cash. The balance sheet, along with the cash flow statement, fills in that part of the story.
So when the P&L raises a question, the balance sheet often holds the answer.
Turning Your P&L Into Better Decisions
At Build Your Books, our monthly bookkeeping clients receive a profit and loss statement, balance sheet, and cash flow statement, along with a walkthrough of what those reports mean for the business. You can see the full list on our bookkeeping services page, and you can learn more about our team and the backgrounds they bring.
If your P&L feels more confusing than clarifying, get in touch with us. We’ll help you understand what your numbers are saying so you can make decisions with more confidence.