Understanding Profit and Loss Statements: A Guide for Small Business Owners
The profit and loss statement (P&L, also called an income statement) shows whether your business made or lost money over a period — a month, a quarter or a year. It’s the report most owners look at first, but it’s easy to misread. This guide explains each section, walks through a simple example and lists the questions to ask every month.
The structure of a profit and loss statement
| Line | What it includes |
|---|---|
| Revenue (income, sales) | Sales of products and services, net of discounts and refunds |
| Cost of goods sold (COGS) | Direct costs of what you sold: inventory, materials, direct labor, merchant and fulfillment costs if you classify them here |
| Gross profit | Revenue − COGS |
| Operating expenses | Rent, software, marketing, salaries of non-production staff, insurance, professional fees |
| Operating income | Gross profit − operating expenses |
| Other income and expenses | Interest, gains or losses on asset sales, one-off items |
| Net income | The “bottom line” after all of the above |
A simple example
Imagine an online store for one month:
| Item | Amount |
|---|---|
| Product sales | $60,000 |
| Less refunds and discounts | ($3,000) |
| Net revenue | $57,000 |
| Cost of goods sold | ($25,650) |
| Gross profit (55% gross margin) | $31,350 |
| Operating expenses (ads, software, rent, wages) | ($24,000) |
| Operating income | $7,350 |
| Interest expense | ($350) |
| Net income | $7,000 |
Gross margin is gross profit ÷ net revenue: $31,350 ÷ $57,000 = 55%. COGS is the other 45% of revenue. Net profit margin is $7,000 ÷ $57,000 ≈ 12.3%. Mixing up gross margin, COGS percentage and net margin is one of the most common P&L mistakes; our free margin and markup calculator does the math for you.
Profit is not cash
A profitable month can still leave you short of cash. The P&L doesn’t show loan principal repayments, inventory you bought but haven’t sold, customer invoices you haven’t collected or owner draws. Those appear on the balance sheet and cash flow statement. That’s why we pair monthly reporting with a 13-week cash flow forecast.
Cash vs accrual basis
On a cash basis, income and expenses are recorded when money moves. On an accrual basis, income is recorded when earned and expenses when incurred, whether or not cash has changed hands. Accrual reports usually give a truer picture of monthly performance; cash reports are simpler. QuickBooks Online and Xero can run either view — just be consistent, and ask your CPA or accountant which basis your filings use.
Questions to ask your P&L every month
- Is it based on reconciled books? If bank and card accounts aren’t reconciled, the P&L may include duplicates or miss transactions.
- How did gross margin change? A falling margin can signal rising supplier costs, discounting or COGS errors.
- Which expenses moved the most? Compare to last month and the same month last year.
- Is anything in “Uncategorized” or “Ask My Accountant”? Those balances mean the report is incomplete.
- Are there one-off items? Separate unusual costs so you can see underlying performance.
- How does it compare with budget? A budget-versus-actual report turns the P&L into a planning tool.
Common P&L mistakes
- Recording net payouts from Stripe, PayPal or Shopify as revenue, which hides fees and understates sales.
- Expensing inventory when purchased instead of when sold, which distorts gross margin.
- Booking loan repayments entirely as expense instead of splitting principal (balance sheet) and interest (P&L).
- Recording owner draws or personal purchases as business expenses.
- Including sales tax or GST/HST collected in revenue — it’s a liability, not income.
Get a P&L you can trust
AccoTiva prepares monthly profit and loss statements, balance sheets and cash flow statements with plain-English commentary for small businesses in the US and Canada. See our financial reporting services or book a free consultation.