FINANCIAL LITERACY • 2 MARCH 2026 • 2 MIN READ
What is a profit and loss statement? (and how to interpret it)
SECTIONS
What's included in a profit and loss statement?
Interpreting your profit and loss statement
Making your profit and loss account work for you
Every business owner, whether running a start-up or a well-established company, comes face-to-face with one financial report more often than any other: the profit and loss (P&L) statement, also known as an income statement or statement of income. The P&L shows how much your business earned, how much it spent, and whether the year ended in a profit or loss. The P&L report also acts as a diagnostic tool, revealing whether your pricing works, whether your expenses are under control, and whether the business is heading in the right direction.
Think of it as the story of your business performance over a period of time. But to understand that story properly, you need to know what each part means and how to interpret it.
What's included in a profit and loss statement?
Income
Also known as sales or revenue, income can come from:
- Selling goods
- Providing services
- Clients reimbursing certain expenses
- Earning interest
Understanding income trends helps you spot whether growth is coming from sustainable sales or one-off spikes.
Cost of sales / Direct costs
These costs relate directly to the sale of goods or services. Not all businesses will have a cost of sales section. It’s usually only applicable when you’re selling goods or performing work that involves raw materials (e.g. construction). Businesses in the service industry are likely to exclude this section and only have expenses of an operating nature.
Examples include:
- Purchase of goods (products to sell)
- Purchase of raw materials (for processing, then selling)
- Purchases of materials (used in the construction industry)
- Freight and packaging (both inbound and outbound)
- Commission paid to salespeople
- Contractors and subcontractors
- Maintenance of factory plant and machinery (the more units produced, the more maintenance is required)
- Wages for factory workers (if they’re based on units produced, rather than per hour)
Gross profit
This is income minus direct costs. It tells you whether your pricing and cost structure make commercial sense before everyday running costs are considered.
The gross profit amount should also be able to cover your business's operating expenses.
Operating expenses
These are the everyday costs of running a business. These generally remain consistent, no matter the level of sales.
- Advertising
- Bank fees
- Computer and IT expenses
- Insurance
- Interest
- Office rent
- Power
- Printing, postage, and stationery
- Professional fees (legal, accounting, consulting)
- Telephone and internet
- Salaries
- Staff expenses
Non-cash expenses
These appear on the profit and loss statement but don't involve money leaving the bank.
Examples include:
- Depreciation of property, plant, and equipment
- Gains or losses on the sale of assets
- Certain accountant adjustments, which may include: reimbursing a director or shareholder for using part of the home as an office, adjusting for any private portion of business expenses
Non-deductible expenses
These are business expenses that can’t be deducted from taxable income but are still actual business expenses. They reduce your final profit figure even though they don't have an impact on your tax bill.
Examples of non-deductible expenses include:
- A portion of entertainment expenses
- Certain legal expenses
- Fines and penalties
- Income tax
Net profit or loss
After all income and expenses are taken into account, the final figure is your net profit (or loss). This number tells you how your business is financially performing.
Interpreting your profit and loss statement
As with most financial reports, looking at one set of info is only part of the picture. A P&L statement is most useful when you look beyond the individual numbers and focus on trends, relationships, and changes from year-to-year.
It pays to compare:
- This year (or month) vs last year (or month)
- Actual results vs budget
- Performance vs industry expectations
Patterns are more revealing than standalone figures. If a figure changes significantly, always ask "why?" Small changes can indicate early warning signs long before a problem becomes obvious.
Look closely at your sales
Sales are the starting point of your business performance and should cover all business expenses and provide the owners (shareholders) with a reasonable return. However, higher sales don't always mean higher profit.
Ask yourself these questions:
- Have sales increased or decreased over time?
- Are you pricing your product correctly?
- Are some products selling better than others, and if so, why?
- Do you receive a higher margin on certain products?
- Could you generate more income without adding unnecessary expenses?
Assess the relationship between revenue and direct costs
If direct costs rise faster than revenue, something isn't working. It may signal:
- Rising material or freight costs
- Inefficiencies in production
- Over-stocking or wastage
- Jobs being underquoted
If you run project-based work, analysing job-specific profits can help spotlight which types of work are truly paying off. Compare your direct cost as a percentage of sales each year to quickly see whether efficiency is improving or declining.
Review operating expenses for unusual movements
Day-to-day costs can accumulate quietly. Reviewing this section regularly helps you spot:
- Subscriptions you may no longer need
- Increases in professional fees e.g. legal, accounting, marketing
- Gradual rises in rent, utilities or wages
- Admin or IT costs have crept up
Understand non-cash expenses with perspective
We’re not saying ignore these when analysing your profit and loss account, but the business often has no control over non-cash expenses. They include:
- Depreciation – this may not be a true reflection of your assets’ loss in value as accountants use the maximum deduction allowed by Inland Revenue
- Home office expenses – this is an expense calculated only because Inland Revenue allows a deduction for business owners using part of their home for business purposes
- Motor vehicle reimbursement – similar to home office expenses, an adjustment on your financial statements is for tax purposes
- Depreciation recovered – this pops up on your profit and loss account when the business sells a fixed asset for more than its book value; it’s purely arbitrary as it is directly related to depreciation
- Loss on disposal of assets – this is the opposite to depreciation recovered and happens when the business sells a fixed asset for less than its book value
- Shareholder salary – this is an adjustment made by your accountant as a means of allocating company profit
- Bad debts – considered to be a non-cash expense because you’ve recorded the sale as income but won’t receive payment; we don’t want you paying tax on income you’ll never receive
Evaluate net profit in the context of your needs
Net profit should support the return you expect from running a business.
For sole traders and partnerships, net profit is effectively personal income. Is it enough for you to live on? What changes would you need to make to improve this amount?
For company owners, take into consideration any wages you receive from the company, your shareholder salary (if one has been allocated), and any dividends you receive. Are you happy with this amount as your income?
Profit vs bank balance
A very common frustration for business owners is seeing the business earn a profit but not seeing the money in the bank. This can be due to:
- Buying equipment or vehicles
- Repaying loans
- Increasing stock levels
- Slow customer payments
- Owner drawings
- Non-cash adjustments that affect profit but not cash
Profit tells you how the business performed, but cashflow tells you what is actually happening with the money. Normally, it's about timing differences.
Making your profit and loss account work for you
When you understand how to read your P&L statement, it becomes far more than a compliance document prepared by your accountant once a year. It helps you:
- Adjust product/service pricing with confidence
- Control costs before they become a problem
- Identify your strongest and weakest revenue streams
- Build accurate budgets and forecasts
- Strengthen loan and investment applications
By regularly reviewing your P&L statement, you gain real insight into the health of your business, giving you the confidence to make smarter decisions, plan for growth, and spot issues before they impact your bottom line.
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