How to Read a Profit and Loss Statement: A Guide for Small Business Owners
Most business owners want to know one thing when they open their financial statements:
Is my business actually making money?
That is exactly what your profit and loss statement is designed to help you understand.
Also known as an income statement, the profit and loss statement shows the revenue your company generated, the direct costs associated with earning that revenue, the overhead required to operate the business, and ultimately the profit remaining after those costs are deducted.
But simply looking at the final profit number is not enough.
To properly understand the financial health of your business, you need to know what each section represents, why certain expenses belong in different categories, how to identify unusual changes, and why your profit and loss statement should be reviewed alongside your balance sheet.
At Always Bookkeeping, the balance sheet is reviewed first because problems found there can affect the accuracy of the income statement. Financial statements are also reviewed month by month rather than waiting until year-end, making it easier to identify unusual transactions while they are still fresh.
For owners looking for professional Bookkeeping edmonton support, understanding the basics of your profit and loss statement will help you ask better questions and make better decisions throughout the year.
What Is a Profit and Loss Statement?
A profit and loss statement summarizes the financial performance of your business over a specific period.
It generally contains several main sections:
- Income or revenue
- Cost of goods sold
- Gross profit
- Operating expenses
- Other income or expenses
- Net profit
The basic calculation is straightforward.
Revenue – Cost of Goods Sold = Gross Profit
Then:
Gross Profit – Operating Expenses – Other Expenses = Net Profit
The final net profit shows what remains after the costs of operating the business have been accounted for.
While that formula sounds simple, the usefulness of your income statement depends heavily on transactions being categorized correctly.
If revenue is posted to the wrong place or direct job costs are recorded as ordinary office expenses, your numbers can become difficult to understand.
That is why clean bookkeeping matters.
Why You Should Review Your Profit and Loss Every Month
Many business owners review financial statements only once a year.
Their accountant begins preparing the year-end return, asks for information, and the owner finally looks at how the business performed.
The problem is that the information is now historical.
If expenses became too high six months ago, you cannot go back and reduce them.
If one service stopped being profitable, you may already have spent another year selling it.
If revenue declined, you may have missed an opportunity to respond earlier.
Monthly reviews allow you to spot changes while you can still act on them.
Always Bookkeeping also reviews several months together because comparing periods makes anomalies much easier to identify.
Instead of asking only, “What happened this month?” you can ask:
- Is revenue trending upward?
- Are direct costs increasing?
- Is gross profit improving?
- Which expenses are increasing?
- Is this unusual amount normal?
- Is something missing compared with previous months?
Patterns tell a much more useful story than one isolated number.
Start With Your Income
The first section of the profit and loss statement is normally income or revenue.
This represents money earned through the company’s ordinary business activities.
Depending on the business, you may have multiple income streams.
For example, the company in the source walkthrough has Canadian income and U.S. income. Even though some customers pay in U.S. dollars, the financial report presents those amounts in Canadian currency.
Revenue categories can be useful because they allow you to understand where sales are coming from.
But more categories are not automatically better.
Keep Revenue Categories Simple
Some businesses create five, six, or even more different income accounts.
That can make reports unnecessarily complicated.
Always Bookkeeping generally recommends keeping income categories to three or fewer when possible. This makes the statement easier to read and reduces inconsistency when deciding where transactions should be categorized.
There is also a broader business lesson here.
If you have too many unrelated revenue streams, you may be spreading your attention too thin.
A company trying to sell ten different things may struggle to become excellent at any one of them.
Having one, two, or three clearly defined income streams can make it easier to understand:
- Which service generates the most revenue
- Which offer is growing
- Which service deserves more attention
- Which area may no longer be worth pursuing
Financial statements should simplify decision-making, not make the business harder to understand.
What Is Cost of Goods Sold?
After revenue comes cost of goods sold, often abbreviated as COGS.
These are costs that occur directly because you sold a product or completed a service for a customer.
For a home builder, construction materials may be cost of goods sold.
For a renovation company, materials and certain subcontractors may belong here.
For another service company, direct labour used specifically to complete client work may also be included.
The key question is:
Would this cost exist if I did not have that particular customer or project?
If the answer is no, there is a good chance it may be a direct cost.
The source walkthrough describes materials used to construct a home and certain subcontractor costs as examples of expenses connected directly to generating revenue.
Correctly separating these costs from overhead is important because they determine your gross profit.
Use Monthly Comparisons to Catch Missing Costs
Imagine that your business normally pays a particular subscription or subcontractor every month.
You review six months of statements and see:
April: expense recorded.
May: expense recorded.
June: nothing.
July: expense recorded.
August: expense recorded.
The missing June expense should immediately attract attention.
Maybe there was genuinely no payment that month.
Or maybe it was categorized somewhere else.
Without a multi-month comparison, that error may be easy to miss.
The source video uses this exact approach: regular costs are reviewed across several months so missing or differently categorized transactions can be investigated.
This is one reason professional Bookkeeping edmonton services should involve more than entering transactions into software.
Good bookkeeping includes reviewing whether the numbers actually make sense.
Understanding Gross Profit
Once you subtract cost of goods sold from revenue, you arrive at gross profit.
For example:
Revenue: $100,000
Cost of goods sold: $60,000
Gross profit: $40,000
That $40,000 must still cover all of the overhead required to operate the business.
Gross profit is extremely useful because it helps show how profitable your actual product or service delivery is before general overhead expenses are considered.
If revenue grows but gross profit does not, you may have a problem.
Possible causes include:
- Material costs have increased
- Labour costs have increased
- Subcontractors are becoming more expensive
- Prices are too low
- Discounts are too aggressive
- Low-margin jobs are becoming a larger percentage of sales
Revenue alone cannot tell you this.
A business can generate more sales while becoming less profitable.
Gross profit helps expose that problem.
Understanding Operating Expenses
After gross profit, your profit and loss statement generally shows operating expenses.
These are often called overhead expenses.
Unlike direct costs, these expenses may continue even if you do not complete a customer project that day.
Examples may include:
- Advertising and promotion
- Rent
- Office expenses
- Insurance
- Bank charges
- Interest
- Bad debts
- Administrative payroll
- Professional fees
- Other general operating costs
The source video describes these as the costs you have simply because you operate a business.
The distinction between direct costs and overhead is important because it helps you understand where money is actually being consumed.
List Expenses From Highest to Lowest
One practical recommendation from the source is to display expenses in descending order, starting with the largest.
This makes the report easier to analyze.
If advertising is the largest expense, it appears near the top.
If office supplies are unusually high, that becomes obvious quickly.
Rather than scanning through dozens of categories, you can immediately focus attention on where the company is spending the most money.
The largest expense is not automatically a problem.
Context matters.
A company spending heavily on advertising may be making a deliberate investment to generate sales.
However, if “office expenses” suddenly becomes the largest cost in a trade business, it may deserve investigation.
Perhaps materials were incorrectly posted to office expenses instead of cost of goods sold.
The goal is not to reduce every large expense.
The goal is to understand why it is large and whether the spending makes sense.
Advertising Is an Expense—but It May Be Necessary for Growth
Advertising and promotion can represent a significant expense for some businesses.
That alone does not mean too much money is being spent.
If advertising consistently produces profitable customers, the expense may be justified.
The important question is whether the business understands what it is receiving in return.
A $10,000 advertising expense that generates $100,000 of profitable work may be extremely valuable.
A $2,000 advertising expense that produces nothing may be wasteful.
Your profit and loss statement shows how much was spent.
Your broader business metrics should help explain what that spending produced.
Financial reports become much more useful when connected to actual operational results.
Investigate Large or Unusual Expense Changes
Suppose interest and bank charges are normally around $100 per month.
Suddenly, one month shows $800.
Do not automatically assume the bookkeeping is wrong.
Investigate.
Maybe an annual credit card fee was charged.
Maybe additional interest accumulated.
Maybe another transaction was mistakenly categorized there.
Likewise, insurance may appear monthly if it is paid through instalments or only once a year if the business pays annually.
Missing an expense in a particular month is not necessarily a problem.
The important thing is being able to explain why.
The source emphasizes that variation can be completely legitimate as long as the reason is understood.
A financial statement should make sense in the context of how your company actually operates.
Where Should Payroll Go?
Payroll is one area where categorization can become more complicated.
Not every employee necessarily belongs in the same section of the income statement.
Suppose you have an employee whose entire job is completing customer projects.
Their wages may be treated as a direct cost because you pay them to deliver the service being sold.
Now consider an administrative employee who answers calls, handles invoices, schedules appointments, and manages office duties.
That employee may be classified as an operating expense because the position supports the company generally rather than completing a specific customer job.
Some employees perform both roles.
For example, someone might spend:
- 80% of their time performing direct client work
- 20% of their time on administration
In that situation, payroll may be split between cost of goods sold and operating expenses.
The source specifically explains this distinction and notes that payroll can be divided according to how an employee actually spends their time.
Proper classification gives you a much clearer understanding of the true cost of delivering your services.
Understanding Other Income and Expenses
Some transactions do not fit cleanly into normal operating revenue or overhead.
These may appear under other income or other expenses.
In the source example, foreign exchange gains and losses appear because the business works with U.S. customers.
Another possible example is a corporation that owns a rental property.
The income and expenses associated with that property might be separated from ordinary operating expenses so the owner can distinguish the rental activity from the primary business.
Separating unusual or secondary activities can make the core business much easier to evaluate.
You want to know whether your main operation is profitable without unrelated activities making the picture confusing.
Gross Profit vs. Net Profit
These two numbers are often confused.
Gross Profit
Gross profit is:
Revenue – Cost of Goods Sold
It tells you how much remains after paying the direct costs associated with delivering your product or service.
Net Profit
Net profit is what remains after overhead and other relevant expenses are also deducted.
The source summarizes the calculation as income minus cost of goods sold, giving gross profit, followed by operating and other expenses to arrive at final net profit.
Net profit is ultimately one of the most important numbers on the statement.
It tells you whether the company produced a profit after accounting for its business expenses.
Revenue Can Increase While Profit Falls
This is an important concept for growing companies.
Imagine:
Year One
Revenue: $500,000
Net profit: $100,000
Year Two
Revenue: $700,000
Net profit: $70,000
Sales increased by $200,000.
Yet the business made $30,000 less profit.
If the owner focuses exclusively on revenue, Year Two looks much better.
But profitability has actually deteriorated.
Possible explanations include:
- Labour became too expensive
- Material costs increased
- Advertising became less efficient
- Pricing failed to keep up with costs
- Overhead expanded too quickly
- The company accepted too many low-margin jobs
Growth should be measured by more than sales.
More revenue is useful only when the economics of the business remain healthy.
Your Profit and Loss Should Be Read With Your Balance Sheet
Although the income statement tells you whether you generated a profit, it should not be reviewed alone.
Always Bookkeeping reviews the balance sheet first because unusual balances there can reveal issues that affect the income statement.
For example, transactions may be incorrectly recorded, bank accounts may not reconcile, or balances may exist that need correction.
Your financial statements are connected.
The balance sheet shows what the company owns, owes, and retains.
The income statement shows how the company performed financially over a period.
Reviewing both provides much more context than looking at profit alone.
Common Profit and Loss Warning Signs
You do not need to be an accountant to notice when something deserves a closer look.
Revenue Suddenly Drops
Ask whether the decrease reflects actual sales performance or whether transactions are missing.
Revenue Increases but Gross Profit Falls
Direct costs may be increasing faster than pricing.
A Regular Expense Disappears
Check whether it was genuinely not incurred or whether it was categorized incorrectly.
One Expense Category Becomes Unusually Large
Investigate the transactions inside that category.
Gross Profit Percentage Changes Dramatically
Review pricing, materials, labour, and subcontractor costs.
Bank Charges or Interest Increase
Determine whether additional debt, fees, or unusual charges occurred.
Too Many Income Categories
Simplifying the statement may make your business easier to understand.
Net Profit Keeps Declining
Do not wait until year-end to determine why.
These signals do not necessarily mean something is wrong.
They tell you where questions should be asked.
Questions to Ask When Reviewing Your Income Statement
Each month, consider asking:
Is revenue moving in the right direction?
Compare the latest period with previous months.
Are my direct costs reasonable?
Look at whether cost of goods sold is increasing proportionally with revenue.
What is happening to gross profit?
A shrinking gross margin can indicate pricing or cost problems.
What are my largest overhead expenses?
Start with the largest amounts and determine whether they make sense.
Are there unusual changes?
Investigate sudden increases, decreases, or missing categories.
Are transactions being categorized consistently?
Inconsistent bookkeeping makes comparisons less reliable.
What is my actual net profit?
Do not confuse sales with profitability.
A million-dollar company with almost no profit may be financially weaker than a smaller company with healthy margins.
Use Your Income Statement to Make Decisions
The purpose of a profit and loss statement is not simply tax preparation.
It should help you manage the business.
Your financial information can help you decide:
- Whether prices should increase
- Whether advertising spending is justified
- Whether labour costs are sustainable
- Whether a service should be discontinued
- Whether a particular revenue stream deserves more investment
- Whether overhead is growing too quickly
- Whether the company is becoming more or less profitable
Monthly reports turn bookkeeping into a management tool.
Annual reports mostly tell you what already happened.
That distinction is significant.
You Do Not Need to Understand Every Accounting Detail
Business owners do not need to become bookkeepers.
But you should be able to understand the broad story your financial statements are telling.
You should know:
- How much revenue you generate
- What it costs to deliver your service
- Your gross profit
- Your major overhead expenses
- Your net profit
- How those numbers are changing
If something does not make sense, ask.
A good bookkeeper should be able to explain the reports without burying you in accounting terminology.
The goal is confidence.
You should be able to look at your financial statements and understand whether the business is moving in the right direction.
The Biggest Profit and Loss Takeaway
Your profit and loss statement is one of the most useful tools you have as a business owner.
But do not skip straight to the bottom line.
Start with revenue.
Understand where your sales come from.
Review cost of goods sold and determine what it truly costs to complete customer work.
Look at gross profit.
Review operating expenses from largest to smallest.
Investigate unusual changes.
Understand any other income or expenses.
Then look at net profit.
And always compare your results over several months rather than viewing one number in isolation.
The right Bookkeeping edmonton partner should do more than prepare reports. They should help keep those reports accurate, review unusual transactions, and help you understand what the numbers are actually telling you about your business.
Your income statement is not just paperwork for your accountant.
Used properly, it is a roadmap for understanding where your business is making money, where it is losing money, and what you may need to change next.