Learn how a Profit and Loss Statement shows a business’s income, expenses and profitability over a period, with practical examples and easy-to-follow calculations.
What Is a Profit and Loss Statement?
A Profit and Loss Statement, also known as a P&L Statement or Income Statement, is a financial report showing a business’s income and expenses over a specific period.
It helps determine whether the business has made a profit or incurred a loss.
A Profit and Loss Statement may be prepared monthly, quarterly or annually.
Why Is a Profit and Loss Statement Important?
- Measures business profitability
- Helps identify rising expenses
- Supports budgeting and financial planning
- Allows comparisons between accounting periods
- Helps business owners make informed decisions
- Provides information for tax and financial reporting
Main Sections of a Profit and Loss Statement
1. Revenue (Sales)
Revenue represents income earned from the business’s ordinary activities, such as selling goods or providing services.
Sales returns and discounts may reduce the amount of revenue reported.
2. Cost of Sales
Cost of sales represents costs directly attributable to goods sold or services delivered, depending on the nature of the business.
For a retailer, this might include the purchase cost of inventory sold.
3. Gross Profit
Gross profit is calculated by subtracting cost of sales from revenue.
4. Operating Expenses
Operating expenses are costs incurred in running the business.
Examples include:
- Office rent
- Administrative salaries
- Insurance
- Marketing and advertising
- Telephone and internet
- Depreciation
5. Net Profit
Net profit is the amount remaining after deducting all relevant expenses, including finance costs and tax where applicable.
Some management reports instead present profit before tax or other intermediate profit measures.
Practical Profit and Loss Example
Imagine a small UK retail business preparing its Profit and Loss Statement for the year ended 31 December.
The business has the following figures. For simplicity, VAT is excluded.
| Profit and Loss Statement | Amount (£) |
|---|---|
| Sales Revenue | 80,000 |
| Cost of Sales | (32,000) |
| Gross Profit | 48,000 |
| Rent | (12,000) |
| Salaries | (18,000) |
| Insurance | (2,000) |
| Marketing | (3,000) |
| Depreciation | (1,000) |
| Total Operating Expenses | (36,000) |
| Operating Profit | 12,000 |
| Finance Costs | (1,000) |
| Profit Before Tax | 11,000 |
| Tax Expense (illustrative) | (2,000) |
| Net Profit After Tax | 9,000 |
The tax expense above is an assumed amount for teaching purposes, not a calculation of UK tax liability.
Step 1: Calculate Gross Profit
£80,000 − £32,000 = £48,000.
Step 2: Calculate Operating Profit
£48,000 − £36,000 = £12,000.
Step 3: Calculate Net Profit
£12,000 − £1,000 − £2,000 = £9,000.
What Is Gross Profit Margin?
Gross profit margin measures gross profit as a percentage of revenue.
In our example:
(£48,000 ÷ £80,000) × 100 = 60%.
This means that 60p of every £1 of sales remains after deducting cost of sales, before operating and other expenses.
What Is Net Profit Margin?
Net profit margin measures net profit as a percentage of revenue.
In our example:
(£9,000 ÷ £80,000) × 100 = 11.25%.
Profit Is Not the Same as Cash Flow
A business can report a profit while experiencing cash flow difficulties.
Under accrual accounting, revenue can be recognised before the customer pays.
Similarly, some expenses may be recognised before or after cash is paid.
Purchasing equipment may reduce cash immediately, while its cost is generally recognised through depreciation over its useful life.
Profit and Loss vs Balance Sheet
| Profit and Loss | Balance Sheet |
|---|---|
| Reports performance over a period | Reports financial position at a date |
| Shows income and expenses | Shows assets, liabilities and equity |
| Calculates profit or loss | Shows what the business owns and owes |
Profit and Loss Reports in Accounting Software
Xero, QuickBooks and Sage provide Profit and Loss reporting features, although report layouts and options differ by platform and subscription.
Depending on the software, users may be able to:
- Select a reporting period
- Compare current and previous periods
- Review income and expense categories
- Investigate transactions behind reported figures
- Export reports for further analysis
Common Profit and Loss Mistakes
- Confusing profit with cash in the bank
- Recording capital equipment as an ordinary expense
- Omitting accrued expenses
- Failing to account for prepayments
- Incorrectly classifying costs between cost of sales and overheads
- Comparing periods without considering seasonal changes
- Including recoverable VAT as income or expense
Test Your Knowledge
A business has the following annual figures:
- Revenue: £50,000
- Cost of sales: £20,000
- Operating expenses: £18,000
What are its gross profit and operating profit?
Click to reveal the answer
Gross Profit: £50,000 − £20,000 = £30,000.
Operating Profit: £30,000 − £18,000 = £12,000.
The gross profit margin is 60%, while the operating profit margin is 24%.
Learn to Prepare Financial Reports in Practice
Understanding the Profit and Loss Statement is an essential bookkeeping skill. Take the next step with our practical accounting software courses covering Xero, QuickBooks and Sage.