How to read a profit and loss statement

The profit and loss statement, often called the P&L or income statement, is the report most owners look at first. business.gov.au describes it as a statement that “lists your sales and expenses”, and says you usually complete one every month, quarter or year. It shows performance over a period, not your position on one day.

What is on a profit and loss statement

Most P&Ls follow the same order, from top to bottom.

Revenue

Revenue, also called sales or turnover, is what you earned from customers in the period, before any costs. Most businesses show it excluding GST, because GST belongs to the ATO.

Cost of goods sold

Cost of goods sold (COGS), sometimes called cost of sales or direct costs, is what it cost to produce or buy the things you sold. business.gov.au defines it as “the total direct costs of producing a good or delivering a service”. For a retailer, that is mainly the stock you sold plus freight. For a trade business, it may include materials and the wages of the people doing the work.

Gross profit and gross margin

• Gross profit = revenue minus cost of goods sold
• Gross margin = gross profit divided by revenue, times 100

Gross profit shows what your sales earn before overheads. Gross margin turns that into a percentage, so you can compare months or years even when sales change. A 40% gross margin means you keep $40 from every $100 of sales to pay your running costs and leave a profit.

Operating expenses

Operating expenses, or overheads, are the costs of running the business that don’t rise and fall directly with each sale. Examples include rent, office wages, marketing, insurance, software, accounting fees, depreciation on equipment and interest on loans.

Net profit

• Net profit = gross profit minus operating expenses

This is the bottom line. business.gov.au calls net profit “the money left over after you paid expenses”. Some P&Ls show net profit both before and after income tax.

• Net profit margin = net profit divided by revenue, times 100

A quick word on EBITDA

EBITDA means earnings before interest, tax, depreciation and amortisation.

• EBITDA = net profit before tax plus interest plus depreciation plus amortisation

It strips out how the business is funded (interest), tax, and the gradual write-off of equipment and other long-term assets (depreciation and amortisation). What is left is a rough measure of what the day-to-day operations earn.

You will hear it mentioned in two places:

• Business buyers and sellers often talk about a business’s value in terms of its EBITDA or earnings, because it lets them compare businesses with different loans and equipment.
• Lenders may use it as a starting point to see how much the business earns before paying interest on any debt.

EBITDA is not cash and not profit. It ignores the cost of replacing equipment, loan repayments and tax, which all still need to be paid. Treat it as one view of the business, not the whole story.

Worked example

A Melbourne homewares shop with an online store has $800,000 in yearly sales. Here is its P&L for the year (figures exclude GST).

Line	Amount
Revenue	$800,000
Cost of goods sold (stock sold and freight)	$440,000
Gross profit	$360,000
Wages and super	$180,000
Rent	$60,000
Marketing	$30,000
Software, insurance and other overheads	$25,000
Depreciation	$10,000
Interest	$5,000
Total operating expenses	$310,000
Net profit before tax	$50,000

The calculations:

• Gross profit: $800,000 minus $440,000 is $360,000.
• Gross margin: $360,000 divided by $800,000 is 45%.
• Net profit: $360,000 minus $310,000 is $50,000.
• Net profit margin: $50,000 divided by $800,000 is 6.25%.
• EBITDA: $50,000 plus $5,000 interest plus $10,000 depreciation is $65,000. There is no amortisation.

In plain terms, from every $100 of sales, $55 pays for the stock sold, $38.75 pays the running costs and $6.25 is left as profit before tax.

Now suppose supplier prices rise by 5% and the shop does not change its prices. Cost of goods sold rises to $462,000 ($440,000 times 1.05). Gross profit falls to $338,000 and gross margin to 42.25%. With the same overheads, net profit falls to $28,000. A 5% rise in stock costs has cut net profit by $22,000, or 44%. That is why small changes in gross margin matter so much.

What the P&L may tell you

• Is the business profitable? The bottom line answers this for the period.
• Are your prices right? A falling gross margin can mean costs are rising faster than prices, you are discounting more, or your sales mix has shifted to lower-margin products. The lesson on margins and break-even goes further.
• Where is the money going? Looking at each expense as a share of revenue shows which costs are growing faster than sales.
• How do you compare? The ATO publishes small business benchmarks so you can compare your business with similar businesses in your industry. The ATO’s benchmark ratios include cost of sales to turnover and total expenses to turnover, each calculated as the amount divided by turnover, times 100.

business.gov.au’s financial health checklist suggests watching for falling sales, low profit margins and more spending than you budgeted for.

What changes may indicate

• Revenue up, net profit flat. Costs are growing as fast as sales. Check gross margin and overheads.
• Gross margin falling. Supplier price rises, heavier discounting, waste or a change in what you sell.
• Overheads rising as a share of revenue. Fixed costs, such as a new lease or extra office staff, have grown ahead of sales.
• One-off items. A large repair or an asset sale can make one period look much better or worse than normal. Ask your accountant to show these separately.

Always compare the same periods, such as this quarter against the same quarter last year, especially if your business is seasonal.

Where to find it

Your accounting software can produce a P&L for any period. Your accountant will also prepare one as part of your yearly financial statements and tax return. business.gov.au has a free profit and loss statement template if you don’t use software. The P&L works alongside your balance sheet, which shows what you own and owe, and your cash flow reports, which show when money actually moves.

The ATO notes that accurate and complete records help you meet your tax, super and employer obligations. A P&L is only as good as the records behind it.

When to talk to an accountant or bookkeeper

• Your gross margin or net profit has changed and you can’t explain why.
• You are not sure which costs belong in cost of goods sold and which are overheads.
• Your P&L shows a profit but you are always short of cash. See profit vs cash flow.
• You are preparing to sell the business or apply for finance, and someone has asked about EBITDA or “normalised” earnings.

A bookkeeper can keep your records accurate and categorised consistently. An accountant can explain what the results mean and how they compare with your industry.

Where this matters for business finance

If you ever apply for finance, your P&L is usually one of the first documents a lender will ask for. It shows whether the business earns enough, after its running costs, to meet repayments. Understanding your own P&L first means you can explain any unusual results and decide for yourself whether borrowing makes sense. The last lesson in this course covers what lenders look at.

Important things to know

• A P&L covers a period. It does not show your cash balance or what you owe.
• Profit is not cash. Sales on credit, stock purchases and loan repayments all affect cash differently from profit.
• Categories matter. If costs are put in different categories from one year to the next, your margins will look different even when nothing has changed.
• GST is not revenue. Check that your reports show sales and costs excluding GST.
• EBITDA is a comparison tool. It leaves out real costs, so don’t treat it as money available to spend. Unsure about a term? Check the glossary.