What Is a Profit and Loss Statement and Why Does It Matter?

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A profit and loss statement can reveal where revenue is coming from, which costs are putting pressure on margins and whether the underlying performance of your business is satisfactory.

For UK companies, it is also known as a profit and loss account, P&L account or profit and loss report. Whatever the terminology, understanding what produces the figures and what any changes could mean for your business is the important part. A professional accountant can also help put these figures into context, particularly when changes in revenue, costs or margins are difficult to interpret in isolation.

What does a profit and loss statement show?

It records income and expenditure over a defined period, such as a month, quarter or financial year. It then works through the costs associated with generating that income to arrive at the business’s resulting profit or loss.

The exact layout will vary, but you will generally see revenue, direct costs, gross profit, operating expenses and the resulting operating or net profit. Depending on the business and how its accounts are prepared, you may also see items such as interest, depreciation and taxation.

All these figures are connected. Revenue might increase, but if the cost of delivering those sales rises faster, gross profit can fall. Likewise, a healthy gross margin can be eroded by increasing overheads further down the statement.

How to read a profit and loss statement

Knowing how to read a profit and loss statement is largely about looking for movement, rather than isolated figures. Revenue increase is useful information, but needs context. Is the business selling more? Have prices increased? Is one particularly large customer responsible for the change? Has a new product or service contributed to the growth?

Then look at gross profit. This shows how much remains from sales after the direct costs associated with producing goods or delivering services have been accounted for. For example, a business could increase turnover by 15% but see its gross profit margin fall because supplier prices have increased or discounts have become more common. On the surface, sales are heading in the right direction, but the margin tells a different story.

The next area to examine is operating expenditure. Rent, payroll costs, insurance, professional fees, software, vehicles, marketing and other overheads can gradually increase without attracting much attention individually. Viewed together on a profit and loss statement, however, they may explain why an apparently successful period has produced less profit than expected.

Why comparing periods matters

One period’s profit and loss report is useful, but a series of them is more revealing.  The key is to study trends, such as if revenue has increased consistently while gross margins have declined, or if sales have remained stable, but overheads have risen.

A business can be profitable while still falling short of the performance it had planned for. A profit and loss statement is a management tool, rather than simply an accounting document.

Increasing revenue vs increasing profitability

Turnover can be an attractive number, particularly when it’s growing, but revenue alone doesn’t tell the full story. Consider a business that wins a large new contract, but has to offer lower prices, take on additional staff and absorb higher delivery costs to fulfil it. Revenue increases, but the additional work may contribute relatively little to the bottom line.

Gross profit and profit margins need regular attention to show whether growth is translating into financial value or simply creating more activity.

Is profit the same as cash?

Don’t assume that reported profit means extra money is sitting in the bank. A P&L statement is concerned with income earned and costs incurred during the accounting period, rather than tracking when money enters or leaves the business account.

A business may issue an invoice in March and recognise the associated income in its accounts, but the customer may not pay until April. The business can report a profit while still waiting for a significant amount of cash to arrive. The reverse can happen too. Paying for equipment or settling a previous liability can affect cash, without necessarily appearing as a current period expense in the same way.

Profit and loss should be considered alongside cash flow information when making financial decisions. Profitability and liquidity are related, but they answer different questions.

What a P&L does not tell you

It doesn’t show everything the business owns and owes at a particular point in time. This is where the balance sheet becomes important, showing assets, liabilities and shareholders' equity. It also doesn’t provide the same view of movements in cash as a cash flow statement.

The distinction matters when making decisions about investment, borrowing, hiring or taking money out of the business. The P&L statement is part of the wider financial picture. Used alongside the balance sheet and cash flow information, it makes it easier to understand what’s happening beneath the numbers.

Help small business decision-making

A profit and loss statement for small business use determines which measures matter most to your company, with the most useful steps depending on the particular business model. The figures provide a starting point. The real value comes from understanding the story behind them.