Skip to main content

How to read a profit and loss statement

Your profit and loss statement is a key business tool. ANZ explains how it can help you understand how your business is performing – and where you need to focus to make it perform better.

By ANZ Biz Hub

What is a profit and loss (P&L) statement?

It’s sometimes referred to as an income and expenditure account or a statement of financial performance.

Whatever it’s called, its main purpose is to list all your income and expenses, and the difference between the two – which is your profit or loss.

It usually shows the figures for this year and last, so it’s a great way to compare performance over time.

Every business produces a P&L at least once a year for their annual tax return, as well as a balance sheet. But with modern accounting software you can produce them at the click of a button – and producing quarterly or even monthly P&Ls can help you spot trends and take action to address them earlier.

Business.govt.nz has a range of information about tax and finance, including a jargon-busting introduction to business finance, and a guide on what to do if your business is operating at a loss.

Sample profit & loss statement

Acme Furniture Company Ltd
Profit & loss statement: 2015 tax year
  20152014
Sales $190,000 $135,000
Less: Cost of sales

These are the direct costs of producing your goods or services, eg if you make wooden garden furniture, the cost of timber, glue, paint and screws but not the cost of running your website or paying staff. Many service businesses won't have any Cost of Sales because they sell only time – they don't buy in raw materials.

   
Production expenses $35,000 $25,000
Postage and packaging $3,500 $2,000
Total cost of sales $38,500 $27,000 
Gross profit $151,500  $108,000
Other income $2,500 $570 
Interest received $1,250 $895
Gross income $155,250 $109,465 
Less: Expenses    
Accountancy fees $1,250 $1,190
Bad debts $500 $250
Electricity $1,200 $1,180
Phone bill $1,450 $1,400 
Vehicle expenses $7,500 $4,650
Office expenses $12,560 $12,200
Depreciation $3,245 $3,680
Shareholder's salaries $60,000 $55,000
Total expenses $87,705 $79,550 
Net profit (before tax) $67,545 $29,915 

The P&L is accrual based, not cash based. That simply means it includes all your income and expenses for the period, whether payment has been made/received or not.

For example, if you’ve invoiced for goods sold but haven’t been paid for them yet, they’re still included on the P&L. This provides a more holistic picture of how your business is performing.

What does the P&L tell you?

The purpose of financial statements is to help you manage your business more effectively. Here is some of the key useful information your P&L gives you.

Gross profit margin

What is it?

This ratio shows whether your average mark-up is sufficient to cover all expenses and show a profit.

How to calculate it:

Divide your gross profit by your sales and multiply by 100 to get a percentage. Using the example above for 2015:

Gross profit of $151,500 ÷ by sales of $190,000 = gross profit margin of 80%.

How to use it:

Compare your gross profit margin with similar businesses in your industry. If it’s lower, you could be underpricing. If it’s higher, and business is slow, you could be overpricing.

Expenses to sales ratio

What is it?

This tells you if your expenses are increasing out of proportion to any growth in business.

How to calculate it:

Divide your expenses by your sales and multiply by 100 to get a percentage. Using the example above for 2015:

Expenses of $87,705 ÷ by sales of $190,000 = 46%. In other words, you incurred $46 of expenses for every $100 of sales.

How to use it:

The lower your expense to sales ratio, the higher your profit. If the ratio is increasing over time, it’s a warning sign that expenses may be getting out of control – and you should look for ways to cut fat out of your business. In our example, the ratio was 59% in 2014 and reduced in 2015 – a good sign.

Other ratios

There are a number of other ways you can analyse the information in your P&L. For example, you can look at the ratio of wages to sales to see whether wages are increasing or decreasing in proportion to any increase in sales. If wages are increasing faster than sales, you may need to take action to either increase your sales or reduce your wage bill.

You can also pick any particular expense that you wish to monitor, such as advertising to sales. This ratio would enable you to measure the effectiveness of your marketing.

Disclaimer:

This material is provided as a complimentary service of ANZ. It is prepared based on information and sources ANZ believes to be reliable. Its content is for information only, is subject to change and is not a substitute for commercial judgement or professional advice, which should be sought prior to acting in reliance on it. To the extent permitted by law ANZ disclaims liability or responsibility to any person for any direct or indirect loss or damage that may result from any act or omissions by any person in relation to the material. This material is for information purposes only. Its content is intended to be of a general nature, does not take into account your financial situation or goals, and is not a personalised financial adviser service under the Financial Advisers Act 2008. It is recommended you seek advice from a financial adviser which takes into account your individual circumstances before you acquire a financial product. If you wish to consult an ANZ Business Manager, please contact us on 0800 269 249.

Contacts address book

If you wish to consult an ANZ Business Manager, please contact us on 0800 269 249.

How helpful was this article?