How to read a profit and loss
Revenue, cost of goods sold, gross profit, operating expenses, and what “net” still is not telling you.
The statement is a stack of subtotals
A profit and loss, or income statement, covers a period: a month, a quarter, a year. It is not a picture of what you own. That picture is the balance sheet. Read the profit and loss from the top.
- Revenue. Sales of services or goods, ideally split if you sell both. Sales tax you collected is not revenue. It is a liability. Refunds reduce revenue or sit in a contra account.
- Cost of goods sold. The direct cost of what you sold. Build it with the COGS calculator when inventory is involved. Subtract it from revenue to get gross profit.
- Gross margin. Gross profit divided by revenue. The gross margin calculator does only that division. A falling margin with flat revenue means the cost of the thing you sell went up, or you discounted, or someone coded freight to the wrong place.
- Operating expenses. Rent, software, insurance, wages, payroll taxes, advertising, professional fees. These do not get more “direct” because they feel important. The category guide is there so this section stays comparable month to month.
- Operating profit. Gross profit minus operating expenses. Depreciation lives here or just below, and it is not cash. A straight-line entry from the depreciation calculator lowers profit and does not lower the bank account.
- Other income and expense. Interest, a late fee you actually earned, a loss on a sale of equipment. Keeping these out of sales revenue stops one odd item from distorting margin.
- Net profit. What is left. It is not the tax you owe, and it is not the cash you can spend. Owner’s draws do not belong on this statement. They belong in equity. See owner’s draw versus salary.
A compact example
Revenue $20,000. Cost of goods sold $8,000. Gross profit $12,000, which is a 60% margin. Operating expenses $9,000, including $500 of depreciation. Operating profit $3,000. No other items. Net profit $3,000. If customers still owe $6,000 of that revenue, cash did not go up by $3,000. The method decides whether the $6,000 is on this statement at all.
Questions worth asking every month
Did any account that was quiet last month explode? A new “miscellaneous” balance usually means the chart of accounts needs a real name. Did payroll tax expense move without wages? Did cost of goods sold post with no sales? Those are coding problems, and they make break-even fiction. The month-end close is when you ask, not after you have already quoted the number to a lender.