What Is a Profit and Loss Statement?
A profit and loss statement, also called an income statement or P&L, summarizes your business's revenue, costs, and expenses over a specific period. It answers the most fundamental question in business: did you make money or lose money? While a balance sheet shows your financial position at a point in time, the P&L shows your financial performance over a period.
Every business owner should be able to read and interpret their P&L, regardless of whether they have an accounting background. You do not need to prepare it yourself -- that is what your accountant or accounting software does. But you absolutely need to understand what it is telling you about your business.
The Structure of a P&L Statement
A P&L follows a logical flow from top to bottom: revenue at the top, costs and expenses in the middle, and profit (or loss) at the bottom. Each section builds on the one above it, and understanding this flow is the key to reading the statement.
| Line Item | Amount (KES) | What It Represents |
|---|---|---|
| Revenue (Sales) | 1,200,000 | Total income from goods or services sold |
| Less: Cost of Goods Sold | (480,000) | Direct costs of producing what you sold |
| Gross Profit | 720,000 | Revenue minus direct costs |
| Less: Operating Expenses | (450,000) | Rent, salaries, marketing, utilities, etc. |
| Operating Profit (EBIT) | 270,000 | Profit from core business operations |
| Less: Interest Expense | (30,000) | Cost of borrowed funds |
| Less: Tax Expense | (72,000) | Income tax for the period |
| Net Profit | 168,000 | The bottom line -- what you actually earned |
Revenue: The Top Line
Revenue, sometimes called the top line, is the total amount of money your business earned from selling goods or services during the period. It is reported before any costs or expenses are deducted. If you sell products, this is the total value of products sold. If you provide services, it is the total value of services rendered.
Be careful not to confuse revenue with cash received. If you sent an invoice for KES 100,000 but the customer has not paid yet, the revenue is still recorded when you delivered the goods or service (under accrual accounting). Revenue can grow while your bank balance shrinks if customers are slow to pay -- which is why you need to monitor both your P&L and your cash flow.
Cost of Goods Sold and Gross Profit
Cost of goods sold (COGS) represents the direct costs of producing or purchasing what you sold. For a retailer, this is the purchase price of inventory. For a manufacturer, it includes raw materials, direct labor, and production costs. For a service business, it might include the cost of subcontractors or direct materials used in delivering the service.
Revenue minus COGS gives you gross profit, which tells you how much you earn after covering your direct costs. Gross profit margin (gross profit divided by revenue, expressed as a percentage) is one of the most important metrics to track. A declining gross margin means your direct costs are eating into your revenue, which could indicate pricing problems, supplier cost increases, or inefficiencies in production.
Operating Expenses: Where the Money Goes
Operating expenses are the costs of running your business that are not directly tied to producing your product or service. These include rent, salaries for non-production staff, marketing, insurance, utilities, office supplies, professional fees, and depreciation. These are sometimes called overhead costs.
- Fixed expenses: Costs that stay the same regardless of sales volume, such as rent, insurance, and salaried staff. These create your break-even threshold.
- Variable expenses: Costs that fluctuate with business activity, like sales commissions, delivery costs, and transaction processing fees.
- Discretionary expenses: Costs you can control or eliminate in the short term, such as marketing spend, training, and travel. These are the first place to look when you need to cut costs.
The Bottom Line: Net Profit
Net profit is what remains after all expenses, interest, and taxes have been deducted from revenue. This is the number that determines whether your business is financially viable. A positive net profit means the business is generating returns. A negative net profit (a net loss) means the business spent more than it earned.
Net profit margin (net profit divided by revenue) tells you what percentage of every shilling earned actually stays in the business. A net margin of 14% means that for every KES 100 of revenue, KES 14 becomes profit. Industry benchmarks vary widely, but most healthy small businesses in Kenya operate with net margins between 10% and 25%. If your margin is below 5%, there is very little room for error.
Warning Signs to Watch For
- Revenue growing but profit shrinking: This usually means costs are growing faster than sales. Check whether you are discounting too aggressively or whether expenses have crept up without justification.
- Gross margin declining over time: This signals problems with pricing, supplier costs, or production efficiency. Investigate which products or services have the lowest margins.
- One expense category dominating: If a single expense line (like marketing or rent) consumes more than 30-40% of your operating expenses, question whether you are getting adequate returns from that spending.
- Consistent losses with no trend toward profitability: A new business may lose money in its first year, but the losses should be decreasing each quarter. If they are not, the business model may need rethinking.
- Large one-time items distorting the picture: A P&L that includes unusual items like equipment write-offs or legal settlements can make a normal period look abnormal. Always identify and separate one-time events from ongoing performance.
Your P&L tells the story of your business performance. Read it monthly, compare it to prior periods and to your budget, and use it to drive decisions. The numbers do not lie, but they only help you if you actually look at them.
