Revenue
Everything you earned from doing business, before any costs. Some statements split this into service revenue, product sales, and so on, which is worth doing if the categories behave differently.
Read this line for its trend and its mix, not its size. Revenue that is flat overall but shifting from a high-margin service to a low-margin one is a business getting worse while looking stable.
Cost of goods sold
The costs that exist only because you did the work: materials, subcontractors, merchant fees, the labor of the people who deliver the service. Sometimes labeled cost of sales or cost of revenue.
The line between this and overhead is a judgment call, and the only thing that matters is that you draw it the same way every month. A category that moves around is worse than a category drawn imperfectly.
Gross profit
Revenue minus cost of goods sold, usually shown with the margin as a percentage.
This is the most informative line on the statement. It tells you whether the work is profitable before overhead, which is to say whether your pricing works. A falling gross margin has only a few possible causes: you are charging less, your costs rose, you are selling a different mix, or the work is taking longer than quoted. All four are worth catching early.
Operating expenses
The cost of being in business whether or not you sell anything: rent, insurance, software, advertising, administrative wages, professional fees.
Scan for two things. Anything that jumped without a reason you recognize, and subscriptions you have quietly kept paying. Also check that owner compensation appears here as a real line. If it does not, every number below is optimistic.
Operating income
Gross profit minus operating expenses. What the business earned from its actual operations, before financing and taxes. Sometimes shown as EBITDA or as operating profit.
This is the honest measure of the business as a going concern, because it excludes one-off items and how the business happens to be financed.
Other income and expense
Interest paid, interest earned, gains or losses on selling equipment, anything that is not the day job. Small in most small businesses, but worth a glance to confirm nothing odd is parked here.
Net income
The bottom line, after everything.
Useful, but less useful than the lines above it, because it blends operations with financing and with one-time events. A good year and a bad year can produce similar net income for entirely different reasons.
The thing that confuses everyone
Profit is not cash. You can show a strong profit and still not make payroll.
The usual reasons, in order of frequency:
- Customers have not paid. Revenue is recorded when earned, not when collected, if you are on accrual accounting.
- Loan principal is not an expense. Repaying principal takes cash but does not appear on the P&L. Only the interest does.
- Equipment purchases are not immediate expenses. Buying a truck spends the cash now and shows up on the P&L gradually as depreciation.
- Owner draws are not expenses either, in most structures. The money leaves; the P&L does not mention it.
- Inventory ties up cash before it becomes cost of goods sold.
This is why the P&L is one of three statements. The balance sheet shows what you own and owe at a point in time, and the cash flow statement reconciles profit to the money that actually moved. Read the P&L first, but do not read it alone.
How to actually use it
Pull it monthly, compare each line to the same month last year rather than to last month, and investigate anything that moved more than about 10% without a reason you can name. Comparing to the same month last year removes seasonality, which otherwise makes every business look like it is collapsing every January.