How to read a profit and loss statement, line by line

A profit and loss statement (P&L, also called an income statement) answers one question: over a stretch of time, did the business earn more than it spent? Your accountant produces one every year for the tax return. You should be reading one every month, because by the time the annual version shows a problem, it has been costing you for twelve months.

This guide walks through each section the way a service company owner should read it, then works a full example. The example company and every number in it are hypothetical. This is general information about reading financial statements, not tax or accounting advice; your accountant decides how items are categorized on your return.

What are the three parts of a P&L?

Every P&L for a service business has the same skeleton, even if your software labels it differently:

1. Revenue (income, sales). What you earned from customers in the period.
2. Cost of goods sold (COGS, direct costs, job costs). Money spent to do the jobs: field wages and the payroll taxes on them, materials, subcontractors, dump fees, rented equipment for a specific job.
3. Operating expenses (overhead). Money spent to keep the company open whether or not a crew went out today: office staff, rent, insurance, trucks, phones, software, marketing, accounting.

Revenue minus COGS is gross profit. Gross profit minus overhead is operating profit (often shown as net profit on a small company's statement, before owner taxes and any interest or other income). Those two subtotals are the reason to read the thing at all.

If you are a sole proprietor, the IRS has you report business income and expenses on Schedule C, which has its own line structure. A management P&L can be organized differently from the tax form, and it should be: you want categories that tell you how the business is running, then your accountant maps them to the return.

Is the P&L on a cash or accrual basis?

Check this before you read a single number, because it changes what "revenue" means. The IRS explains in Publication 538 that under the cash method you count income when you actually or constructively receive it, and under an accrual method you count income when it is earned and expenses when they are incurred, regardless of when money changes hands.

For a service company the difference shows up fast. Finish a $12,000 commercial job on June 28, get paid on August 10, and a cash-basis P&L shows that revenue in August while an accrual P&L shows it in June. Neither is wrong. Most accounting software can flip between the two views with one setting. Many small companies file taxes on a cash basis (ask your accountant which method you use and whether you can switch) but read accrual reports for management, because accrual lines up the revenue with the labor and materials that produced it.

A worked example (hypothetical)

Here is a one-year P&L for a made-up residential painting company with two crews and an office manager. The figures are invented to show the arithmetic. They are not benchmarks, and they say nothing about what your trade or market should earn.

How an owner should read it, line by line:

• Gross margin of 41.6%. Out of every dollar billed, about 42 cents is left after paying for the work itself. That 42 cents has to cover the office, the trucks, insurance and marketing, and then leave profit. If gross margin slips three points in a year, that is about $19,000 of profit gone on this revenue, before overhead changes at all.
• Field labor at 35.9%. This is the line to watch weekly, not yearly. It moves when estimates are low, when crews are slow, or when jobs need return trips. Our hourly rate calculator shows what a labor hour has to sell for once overhead and profit are loaded on.
• Overhead at 27.5%. Most overhead is fixed in the short run. The same $176,000 is due whether revenue is $560,000 or $720,000, which is why a slow year hurts more than the revenue drop alone suggests.
• Operating profit of $90,000. If the owner takes no salary on the books (common for sole proprietors and single-member LLCs, where the owner draws money instead), this $90,000 is also the owner's pay before taxes. That changes the picture. A company that "makes 14%" may really be paying its owner a modest wage for a sixty-hour week.

What should you look for each month?

Run the P&L for last month, for the same month last year, and year to date. Then work through these checks:

1. Every line as a percent of revenue. Dollars grow with volume; percentages show efficiency. Materials going from $8,000 to $9,000 means nothing alone. Materials going from 15% to 18% of revenue means something changed: supplier prices, waste, or quotes that missed the material count.
2. Gross margin trend. Look for a slide over three or four months. A single bad month is often one rough job. A trend is usually pricing that has not kept up with wages and material costs.
3. Labor that hides in overhead. If your foreman's wages are coded to "office" or "wages" lumped together, gross margin looks rosier than it is. Split wages into field and office. The same goes for truck costs that belong to a specific job (a rented lift, a dumpster).
4. Uncategorized and "ask my accountant" lines. A large pile of uncategorized transactions makes the whole report unreliable. Clear it before you read anything else.
5. Owner items mixed in. Personal purchases on the business card distort overhead and create tax headaches. A separate business account and card fixes most of this; see our guide to opening a business account.
6. Marketing against results. The P&L tells you what marketing cost. It cannot tell you which channel produced jobs. That needs lead source tracking in your CRM, tied to the invoice.

Why can a profitable month leave no cash?

The P&L measures earning, not money in the bank. Four things commonly separate them:

• Unpaid invoices. On an accrual report, revenue counts when billed. If customers pay in 45 days, the cash arrives a month and a half later.
• Loan principal. Only the interest on a truck loan is an expense. The principal part of the payment leaves your bank account but never appears on the P&L.
• Equipment purchases. A new trailer or sprayer is usually recorded as an asset and depreciated, so a large check written this month may barely show up on this month's P&L.
• Owner draws and taxes. Money the owner takes out, and the owner's quarterly estimated tax payments, generally do not appear as expenses on a sole proprietor's P&L.

That is why you also need a cash forecast, especially in a trade with a slow season. Our guide to cash flow for seasonal businesses covers how to build one. The balance sheet, which the SBA describes as a snapshot of assets, liabilities and equity, fills in what the P&L leaves out.

How do you turn the P&L into decisions?

A P&L is a report card for the whole company. To act on it, you need to go one level down, to the job.

• If gross margin is falling, pull the last 20 jobs and compare estimated hours and materials to actual. Usually a few job types are the problem. Reprice those, using the job price calculator to rebuild the number from labor, materials, overhead and target margin.
• If overhead is climbing as a percent, either revenue stalled or a fixed cost crept up. List every recurring charge and ask what each one produces.
• If net profit looks fine but the owner is exhausted, price the owner's labor. Put a fair wage for the work you do on the books (even on a scratch copy) and see what profit is left.

Job-level numbers only exist if every job carries its estimate, its actual hours, its materials and its invoice in one record. Our own service companies moved onto a custom CRM for this reason, before we offered one to anyone else: the job record feeds the books, and the books stop being a once-a-year surprise. For an outside look at where your leads and jobs come from, start with a free system quote.

The P&L is also only as accurate as the bookkeeping behind it. If categories are a mess, start with bookkeeping for service businesses, then come back to this page. And when a number on the statement surprises you, ask your accountant how it was categorized before you change prices or cut costs because of it.

Frequently asked questions