How to read your P&L in five minutes

Most business owners receive a profit and loss statement every month and read
one number on it. Usually the bottom one. That is a waste of the only document
that reliably tells you what is happening to your business, and it takes about
five minutes to read properly.

Read it in this order

Not top to bottom. In order of how much each line can teach you.

1. Gross margin, not gross profit

The percentage, not the dollars. Revenue minus cost of sales, divided by
revenue. It answers whether the thing you sell makes money before any of the
overhead of running the business. It should be roughly stable month to month
— and when it moves, something real has changed: supplier pricing, your
own pricing, product mix, or shipping.

2. The same figure last month, and the same month last year

A single month in isolation says almost nothing. A P&L with a comparative
column is a different document from one without, and if yours does not have one,
ask for it — it costs nothing to produce.

3. Your three largest cost lines

Not all of them. In most small businesses three lines account for the large
majority of costs, and the rest is noise. Know which three, and watch them as a
percentage of revenue rather than in dollars — costs rising with revenue is
normal, costs rising faster than revenue is the warning.

4. Anything that moved more than about 20%

Scan the variance column for large swings, in either direction. A cost that
halved is as worth understanding as one that doubled — it often means
something was misposted, or a bill has not arrived yet.

5. Net profit, last

By the time you reach it you already know why it is what it is, which is the
entire point of reading in this order.

If net profit is the first number you look at, every explanation you form afterwards is a guess working backwards.

The four things a P&L will not tell you

1. Whether you have cash. Profit is not cash. A profitable business
   can run out of money, and the way that usually happens is inventory and
   receivables — both of which sit on the balance sheet, not here.
2. What you owe. Loans, credit cards, sales tax held on someone else’s
   behalf. All balance sheet.
3. Which products make money. A P&L aggregates. Product-level
   margin needs cost tracked per unit sold.
4. Whether the numbers are right. A P&L built on unreconciled
   accounts is formatted identically to one built on clean books.

Three checks that catch most errors

• Is there a cost of sales line at all? If you sell physical goods and
  everything sits in one lump of expenses, gross margin cannot be computed and
  the most useful number on the page does not exist.
• Does any line say Uncategorised? A material balance there means the
  statement is provisional, whatever it says at the bottom.
• Does revenue match what your sales channels report? If recorded
  revenue exceeds the channels combined, something is being counted twice.

None of this requires an accounting background. It requires the statement to
be laid out so the questions can be asked — which is a reporting decision,
and one worth insisting on.

Questions we get asked