More orders feel like progress. But if materials cost more, discounts get deeper and staff work longer, a busy business can still earn less. A profit and loss statement helps you see what happened between making a sale and keeping a profit.
You may also see it called an income statement or simply a P&L. It shows revenue and expenses over a period, such as a month, quarter or year. The result tells you whether the business made an accounting profit or loss during that time.
You do not need to read it like an accountant. Start with the sales, follow the costs and ask what each step tells you about the work you are doing.
First check what the report covers
A P&L covers a period. A balance sheet shows a position on one date: the assets a business has, the debts it owes and the owner’s remaining stake. They describe different parts of the same business. My guide to reading a balance sheet explains that other view.
Before comparing two P&Ls, check the dates. A three-month report and a full-year report cannot be compared just by looking at the totals. Nor does a busy holiday quarter tell you what to expect in a quiet season.
Also check whether the figures are actual results or a forecast. A forecast says what you expect to happen. The actual P&L says what has been recorded. Comparing them can show where the plan needs changing, but only if you know which is which.
Revenue is the beginning of the calculation
Revenue, sometimes called turnover or sales, is what the business earns from selling its goods or services. It is not automatically the money left for the owner. Most businesses have costs to meet before anything is left.
For a business charging VAT, revenue normally excludes the VAT collected for the government. When purchase VAT can be reclaimed, it is also kept out of the related expense. If it cannot be reclaimed, it can form part of a cost or an asset’s purchase value. Use figures prepared on the same basis.
This article uses euros for its examples. The basic reading method is useful in many countries, but accounting and tax rules differ. In particular, do not assume that every expense shown in a financial report receives the same treatment on a local tax return.
Under the usual accrual approach, a sale belongs to the period in which the goods or service are supplied, rather than simply the day cash arrives. Some small businesses use different permitted methods, especially for tax. Establish how your own report is prepared before interpreting a change.
Follow a small studio from sales to profit
Imagine a ceramics studio selling mugs, bowls and other pieces. The following invented quarter uses amounts without recoverable VAT:
| Item | Quarterly amount |
|---|---|
| Revenue | €40,000 |
| Direct cost of products sold | €16,000 |
| Gross profit | €24,000 |
| Rent | €4,000 |
| Staff costs | €6,000 |
| Other operating costs | €4,000 |
| Depreciation | €1,500 |
| Operating profit | €8,500 |
| Interest | €500 |
| Profit before tax | €8,000 |
Gross profit is revenue minus the direct cost of the products sold. Here, €40,000 minus €16,000 leaves €24,000. That amount still has to cover the other costs of keeping the studio running.
After rent, staff, other operating costs and depreciation, operating profit is €8,500. Subtracting €500 of interest leaves €8,000 before tax. This is a simplified report. A real studio may divide costs differently or have other income and expenses.
The useful point is the sequence. A sale creates revenue. The product uses resources. The wider business has running costs. Financing and taxes can take another share. Looking only at the first or last number hides the steps in between.
Gross margin helps explain a change
Gross margin expresses gross profit as a percentage of revenue. In the studio example, €24,000 divided by €40,000 is 60%. In other words, each euro of sales leaves 60 cents before the remaining costs in the example.
This is not a recommended target for a ceramics business. Different products, production methods and cost classifications give different margins. The number becomes useful when you compare it with your own previous figures prepared in the same way.
Suppose an item sells for €100 and its direct cost is €40. It contributes €60 towards the rest of the business. You reduce the price to €90 but the direct cost stays at €40. The contribution is now €50.
To produce the same €600 contribution that ten full-price sales gave you, you would need twelve discounted sales. That is 20% more items. This simple calculation assumes the extra sales do not increase other costs. If they require extra staff time or deliveries, the extra volume needed could be higher.
A discount may still be worthwhile. It might clear old stock or bring in customers you want to keep. The calculation simply makes the trade-off visible: a modest price reduction can require a bigger increase in sales than it first appears.
Buying something and using it are different events
Imagine buying materials near the end of March that will be used for products sold later. Under the usual approach, unused stock remains an asset. Its cost is not all charged against March’s sales just because the supplier was paid then.
When stock is sold, the related cost moves into the P&L. Stock that is damaged or cannot be sold at its recorded value may need a reduction in value. A stock count therefore affects more than the appearance of the shelves. It helps make the reported profit credible.
Equipment creates another timing difference. A kiln or machine may help the business for several years. Depreciation spreads the relevant cost across its expected useful life instead of charging the whole amount to one period.
For a separate simple example, equipment costs €6,000 and is expected to be worth €1,000 after five years. Spreading the €5,000 difference evenly gives €1,000 depreciation a year. The appropriate useful life, remaining value and tax treatment depend on the asset and local rules.
You may have paid all €6,000 at the start. The later annual depreciation is then an expense without another payment for the same purchase. This is one reason profit does not equal the change in the bank balance.
Borrowing money does not create revenue
A loan increases the cash available, but it also creates a debt. It is not a sale and does not make the business more profitable on the day it arrives.
Repaying the principal, meaning the borrowed amount itself, reduces that debt. It is not an operating expense. Interest is a separate cost of borrowing and can appear in the P&L, as it does in the studio example.
This distinction matters when a business seems profitable but its monthly repayments feel heavy. The P&L may show the interest while the bank account must also fund the principal repayments. My article on making a profit but running short of cash explains how to plan for that gap.
Has the owner’s work already been paid for?
A profit figure needs context. In a sole trader business, money transferred to the owner’s personal account is generally a withdrawal, not a salary expense. The profit must therefore support the owner as well as leave room for tax and money retained in the business.
In a company, an owner’s salary may already be included in staff costs. A company showing €20,000 profit after paying that salary is in a different position from a sole trader showing €20,000 before paying for the owner’s living costs. The legal form and local rules matter.
For a Dutch eenmanszaak, private withdrawals do not reduce business profit. Personal income tax is calculated through the owner’s tax return. A Dutch BV has a separate corporate tax calculation. Accounting profit can also differ from taxable profit because tax rules make adjustments.
So ask what the profit has to cover next. How much of your own time produced it? Is there room for tax, replacing equipment and keeping the business going during a quieter period? These questions help you judge the result without pretending that one percentage suits every business.
Use the report to choose the next action
A useful review ends with a specific question. If revenue rose but gross margin fell, look at prices, purchasing costs, waste and the mix of products sold. If gross profit held up but operating profit fell, examine the running costs below it.
Separate an ongoing increase from a one-off expense. Paying to fit out a larger workspace has a different meaning from permanently needing more staff for the same sales. Check that the accounting treatment is right before deciding the business has become less efficient.
Keep the records current enough to support those decisions. Missing supplier bills can make profit look too high. Old unpaid customer invoices may need attention or an adjustment. My guide to small business bookkeeping shows how regular habits improve the figures you rely on.
If your business is in the Netherlands, I can help prepare annual accounts and explain the figures. Reviewing the P&L alongside the balance sheet helps connect the year’s earnings with unpaid bills, debts and cash. The report then becomes something you can use to make your next business decision.