Reading a Profit-and-Loss Statement
Part B: Understand the Money
Say you run a plumbing company and you have a very good year by every measure you can see. The phone rings, the crew is busy, the trucks are out every day. Then somebody asks what the business actually earned, and your answer is, “Well, the bank account is still there.” That is your whole financial report.
A profit-and-loss statement, usually called a P&L, is the report that answer is missing. It covers a stretch of time, a month or a quarter or a year, and it answers one question: during this period, what did the business earn after paying for everything it took to earn it?
The four blocks of a P&L
Every P&L, however fancy the software makes it look, is built from four blocks stacked top to bottom. Revenue is what customers paid or were billed for the work you did. Direct costs are the things you only spend because you did that work: materials, the crew’s time on the job, subcontractors, food for the plates you sold. Subtract the second from the first and you have gross profit.
Below that sit your overhead costs, the ones that show up whether you had a busy month or a slow one: rent, insurance, software, phones, advertising, the office person. Subtract overhead from gross profit and you have net profit, the bottom line. If you want the full story on why those two profit numbers tell you different things, I wrote it up in Gross Margin Versus Net Margin.
Here is a labelled example. Say a small contracting business does $40,000 of work in a month. Materials come to $12,000 and the crew’s job labor to $10,000, so direct costs are $22,000 and gross profit is $18,000. Rent, insurance, advertising and software add up to $7,000 of overhead. Net profit is $18,000 minus $7,000, which is $11,000.
How to read it, not just look at it
Many owners glance at the bottom line and stop. The bottom line tells you the result. The lines above it tell you why. So read a P&L the way you would read a map, top down, asking a question at each stop.
At revenue: is this more or less than last month, and do I know why? At direct costs: did they grow at the same speed as revenue? If revenue rose by a quarter and materials rose by a third, something is leaking, whether that is waste, a supplier price change, or jobs quoted too low. At overhead: is there a line here I could not explain to a stranger? And at the bottom: is the business paying me, and paying for itself, out of what the work earns?
A P&L shows profit, and profit is not cash. If your books are on the accrual method, a customer invoiced in January but paid in March shows up in January’s revenue and in nobody’s bank account. On the cash method it would not show up until March, which is one reason to ask your accountant which method your P&L uses. So a P&L can look healthy while the checking account looks thin. The report is fine; it is just answering a different question than your bank balance does.
Two habits make the report far more useful. Put your own numbers next to last month’s, side by side, because a single month means little on its own and a trend means a great deal. And keep your categories few and consistent. Twenty tidy lines you understand beat sixty lines you never look at.
What people mean when they say EBITDA
Sooner or later a banker or a buyer will use the word EBITDA, pronounced “ee-bit-dah.” It is your net profit with four things added back: interest, income taxes, depreciation and amortization. Depreciation spreads the cost of a truck or a piece of equipment over the years you use it, instead of counting the whole price the year you bought it, and amortization does the same for things you cannot touch, like a purchased customer list. Say a business shows a net profit of $30,000, with $4,000 of loan interest, $5,000 of income tax and $6,000 of depreciation inside its P&L. Add those back and you get $45,000, which is its EBITDA. Lenders and buyers like the number because it shows what the operation earns before financing and tax choices. But the interest is still owed, the taxes are still due, and the truck will eventually need replacing with real money. EBITDA is neither cash nor take-home pay, and people define it a little differently, so when someone quotes you a figure, ask what was added back. For running your own business week to week, the four blocks above and the lessons on cash will tell you more.
Professional checkpoint: Have a bookkeeper or accountant in your area confirm how your P&L should be set up, which expenses belong in which category, how the numbers feed your tax reporting, and how EBITDA should be figured if a lender or buyer asks for it, since the rules for your business type and location are theirs to explain, not mine.
Fill in last month
Open the free Monthly P&L Tracker on the Resources page and fill in last month. Pull revenue from your invoices, direct costs from your receipts and payroll, and overhead from your bank and card statements. If you can only find two lines you are sure of, start there and mark the rest as “estimate.” An honest rough P&L beats a perfect one you never finish.
Setting up the tracker and entering your first month usually takes two to three hours, mostly gathering paperwork. After that, expect about 30 minutes a month if you keep receipts and invoices in one place. It costs nothing beyond the tracker. If you already use bookkeeping software, it can produce a P&L for you, and the same reading habits apply.
Want the next one in your inbox?
The Open Book is one email a month about something we dealt with and how we solved it: a campaign we set up, how we are using AI, what worked, what did not. No selling.