Profit and loss statement: what it is and how it works

Published Thursday 26 March 2026

Table of contents

• What is a profit and loss statement?
• What is a profit and loss statement used for?
• What's included in a profit and loss statement
• How P&L statements work
• How to create a profit and loss statement
• How to read your profit and loss statement
• Profit and loss statement example
• P&L statement vs. cash flow statement
• Manage your business finances with confidence
• FAQs on profit and loss statements

Key takeaways

• Create a profit and loss statement by gathering all revenue records and expenses for your chosen period, then subtract total costs from total revenue to determine if your business made a profit or loss.
• Review your P&L statement regularly to track profitability trends, spot rising costs, and make informed decisions about pricing, hiring, and spending based on real financial data.
• Calculate your gross profit margin by dividing gross profit by revenue to measure how efficiently you deliver products or services, and monitor your net profit margin to assess overall business health.
• Use accounting software to automate P&L statement creation from daily transactions, giving you real-time access to your profitability without manual calculations.

What is a profit and loss statement?

A profit and loss statement (also called a P&L or income statement) is a financial report that shows how much your business has earned and spent over a specific period. It tells you whether you made a profit or had a loss.

You can prepare a P&L statement for any timeframe, though most businesses create one monthly, quarterly, or annually.

Your P&L summarizes all income and expenses recorded during the reporting period. The basic formula is simple: total revenue minus total expenses equals profit or loss.

Here's what a P&L statement tracks:

• Income: All sales revenue, including credit sales not yet paid by customers
• Expenses: Costs like payroll, advertising, rent, and insurance, including bills you've incurred but not yet paid
• Net income: A positive result, meaning you earned more than you spent
• Net loss: A negative result, meaning expenses exceeded revenue

Your P&L also helps you calculate profit margins, which show how efficiently your business converts revenue into profit.

What is a profit and loss statement used for?

A P&L statement shows you clearly how your business performs, helping you decide how to spend, price, and grow.

Here's what you can use it for:

• Track profitability: See whether your business is making or losing money over time
• Prepare for tax season: Provide accurate income and expense records for your tax return. For tax purposes, government bodies like the Canada Revenue Agency require standardized financial data, with specific codes for items reported on your income statement.
• Apply for financing: Show lenders and investors proof of your business performance
• Spot trends: Identify which months are strongest and where costs are climbing
• Set goals: Compare actual results against your budget to measure progress
• Make decisions: Use real numbers to guide pricing, hiring, and spending choices

What's included in a profit and loss statement

A P&L statement has four main sections that work together to show how profitable your business is. For official tax filings, accountants break these sections down into more detail; for example, the Canada Revenue Agency's General Index of Financial Information (GIFI) provides a list of about 100 commonly used income statement items for standardized reporting.

• Revenue: All money earned from sales and services during the reporting period
• Cost of Goods Sold (COGS): Direct costs to produce or deliver what you sell, such as materials, manufacturing, or contractor fees
• Operating expenses: Day-to-day costs of running your business, including rent, salaries, utilities, marketing, and insurance
• Net income or loss: The final number after subtracting all costs from revenue

Some P&L statements also show gross profit, which is revenue minus COGS. This tells you how much you're making before accounting for overhead costs.

How P&L statements work

A P&L statement follows a simple top-to-bottom flow that calculates your profit in stages.

Here's how it works:

1. Start with total revenue from all sales and income sources
2. Subtract Cost of Goods Sold to get your gross profit
3. Subtract operating expenses from gross profit
4. The result is your net income (profit) or net loss

This structure helps you see exactly where your money comes from and where it goes. If your net income is shrinking, you can trace the problem back to rising costs or falling revenue.

How to create a profit and loss statement

Creating a P&L statement means gathering your financial records and organizing them into the standard format. Here's how to do it:

1. Choose your reporting period (month, quarter, or year)
2. Gather all revenue records, including invoices and sales receipts
3. Add up total revenue from all income sources
4. List all Cost of Goods Sold for products or services delivered
5. Record all operating expenses, such as rent, salaries, utilities, and marketing
6. Subtract COGS from revenue to calculate gross profit
7. Subtract operating expenses from gross profit to get net income or loss

Accounting software like Xero automates this entire process. It pulls data from your daily transactions to generate real-time P&L statements, so you can check your profitability anytime without manual calculations.

How to read your profit and loss statement

Reading a P&L statement helps you understand what the numbers mean for your business. Here's what to look for:

• Revenue trends: Compare revenue across periods to see if sales are growing or declining
• Gross profit margin: Divide gross profit by revenue to see how efficiently you're delivering products or services
• Expense patterns: Review operating expenses to spot areas where costs are rising faster than revenue
• Net income: Focus on the bottom line to see your true profitability after all expenses
• Period comparisons: Compare this month or quarter to the same period last year to identify seasonal patterns

If your net income is shrinking while revenue stays flat, your expenses may be climbing. If gross profit margin is dropping, your direct costs may be too high relative to your prices.

Profit and loss statement example

Here's a simplified P&L statement for a small consulting business covering one quarter:

• Revenue: $50,000
• Cost of Goods Sold: $10,000
• Gross Profit: $40,000
• Operating Expenses: $25,000
• Net Income: $15,000

This example shows the business earned $50,000 in consulting fees, spent $10,000 on direct project costs, and had $25,000 in overhead expenses like rent and salaries. The result is $15,000 in profit for the quarter.

A gross profit margin of 80% ($40,000 ÷ $50,000) indicates the business is delivering services efficiently. The net profit margin of 30% ($15,000 ÷ $50,000) shows healthy overall profitability.

P&L statement vs. cash flow statement

A P&L statement and a cash flow statement serve different purposes in your financial reporting.

A profit and loss statement has these characteristics:

• Shows whether you're profitable over a period
• Includes revenue and expenses when they're earned or incurred
• Records credit sales even if customers haven't paid yet
• Tells you if your business model is working

A cash flow statement has these characteristics:

• Shows actual money moving in and out of your business
• Tracks when cash is received and spent
• Reveals whether you have enough cash to pay bills
• Tells you if you can cover expenses right now

You can be profitable on paper but still have cash flow problems if customers pay slowly. Both statements are important for understanding your financial health.

Manage your business finances with confidence

Understanding your profit and loss statement helps you see your finances clearly and make confident business decisions. Whether you're tracking how profitable you are, preparing for tax season, or applying for a loan, a clear P&L shows exactly where your business stands.

Xero's cloud accounting software automatically generates profit and loss statements from your daily transactions, helping you understand your finances in real time without manual work. You can check your profitability anytime, from anywhere.

Get one month free when you try Xero today. Need help getting started? Find a Xero advisor who can set up your accounting and guide you through your financial statements. Or download the free income statement template to start tracking your finances right away.

FAQs on profit and loss statements

Here are answers to common questions about profit and loss statements.

What does P&L mean?

P&L stands for profit and loss. It's shorthand for a profit and loss statement, which is also called an income statement.

How do you calculate profit and loss?

Subtract your total expenses from your total revenue. If the result is positive, you have a profit. If it's negative, you have a loss.

What's the difference between a P&L statement and a cash flow statement?

A P&L statement shows profitability based on when revenue is earned and expenses are incurred. A cash flow statement shows actual money moving in and out of your bank account.

How often should a small business prepare a P&L statement?

Most small businesses review P&L statements monthly to make management decisions, quarterly to review performance, and annually to prepare for taxes. Accounting software like Xero generates P&L statements continuously.

Can I create a P&L statement myself?

Yes. Accounting software automates P&L creation by pulling data from your transactions. However, if you don't use software, you have other options. For instance, small Canadian corporations with under one million in revenue and assets can use the paper version of the GIFI-Short form for their tax filings. An accountant can help you interpret the results and plan strategically.