Your Profit and Loss Statement Is Trying to Tell You Something

The late-night glow of your computer screen. The bottom-line number on your profit and loss statement that makes you either exhale in relief or tense up in worry.

Most business owners check that one number, maybe glance at a few expense lines, and move on. The rest of the report might as well be hieroglyphics.

But that P&L is telling a story. About where your money comes from. About where it disappears to. About whether last month’s decisions are paying off or slowly bleeding you dry.

Let’s learn to read it.

The Basic Structure

A profit and loss statement follows a logical flow:

Revenue (what you earned)
- Cost of Goods Sold (direct costs to deliver)
= Gross Profit (what's left after direct costs)
- Operating Expenses (cost to run the business)
= Operating Income (profit from core operations)
+/- Other Income/Expenses (stuff outside normal ops)
= Net Income (the bottom line)

Each section tells you something different. Understanding them transforms the P&L from abstract numbers into actionable insights.

Revenue: The Top Line

Revenue is the money your business earns from selling products or services before any expenses are deducted. It’s your top line.

What to Look For

Growth trends: Is revenue increasing, decreasing, or flat? Compare to prior months. Compare to the same month last year.

Revenue mix: Which products or services generate the most income? A Houston marketing agency might discover that one service line generates 60% of revenue but gets 20% of attention.

Seasonality: Do certain months consistently outperform? Many Houston businesses see dips in August and December. Is yours following expected patterns or breaking them?

Revenue Recognition Matters

Under accrual accounting, revenue appears when earned, not when cash is received. Invoice a client in December, get paid in January? December shows the revenue.

This matters for understanding your true monthly performance.

Cost of Goods Sold: The Direct Costs

COGS includes the direct costs of producing your products or delivering your services. These costs vary proportionally with sales. Sell more, and COGS increases.

For Product Businesses

Raw materials
Direct labor (production workers)
Manufacturing supplies
Freight-in costs

For Service Businesses

Direct labor (billable employees, contractors)
Materials used in delivering services
Subcontractor costs on projects

What Doesn’t Belong

Office rent
Administrative salaries
Marketing costs
Utilities for your office

These are operating expenses, not COGS. The distinction matters for understanding your margins.

Gross Profit: Your First Checkpoint

Gross Profit = Revenue - COGS

This number shows how much remains after covering the direct costs of what you sell. It’s the pool available to cover overhead and generate profit.

Gross Profit Margin

Gross Profit Margin = (Gross Profit / Revenue) x 100

A Houston consulting firm with $525,000 revenue and $270,000 in COGS has:

Gross Profit: $255,000
Gross Profit Margin: 48.6%

Nearly half of every dollar earned remains after covering direct service delivery costs.

What This Tells You

Industry comparison: How does your margin compare to competitors? Retail might run 25-35%. Professional services often exceed 50-60%. Know your benchmark.

Trend analysis: Is your margin improving or declining? Declining margins might signal rising costs, price pressure, or changing product mix.

Pricing insight: Low margin often means prices are too low or direct costs are too high. Both deserve investigation.

Operating Expenses: The Overhead

Operating expenses are the costs of running your business that aren’t directly tied to production. Sometimes called overhead or SG&A (Selling, General & Administrative).

Common Categories

Selling expenses:

Advertising and marketing
Sales commissions
Trade show costs

General & Administrative:

Rent and utilities
Office supplies
Insurance
Professional fees (legal, accounting)
Bank fees

Payroll (non-production):

Administrative salaries
Owner’s salary (for S-Corps)
Payroll taxes and benefits

Depreciation:

Equipment depreciation
Property depreciation

The Percentage Test

Calculate each expense category as a percentage of revenue. Is any category unusually high? Increasing over time?

Category	Amount	% of Revenue
Rent	$36,000	6.9%
Salaries (admin)	$72,000	13.7%
Marketing	$24,000	4.6%
Insurance	$12,000	2.3%

If marketing jumped from 4.6% to 8% without a corresponding revenue increase, you need to investigate.

Operating Income: Core Business Performance

Operating Income = Gross Profit - Operating Expenses

This number isolates your business’s operational performance, before interest and taxes. It’s also called EBIT (Earnings Before Interest and Taxes).

Example:

Gross Profit: $255,000
Operating Expenses: $180,000
Operating Income: $75,000

Why This Matters

Operating income shows how well your core business performs, separate from financing decisions. It’s useful for:

Comparing performance across periods
Evaluating operational efficiency
Benchmarking against competitors with different debt structures

Other Income and Expenses

This section captures items outside normal operations:

Other Income:

Interest income from bank accounts
Gains from selling assets
Rental income (if not your primary business)

Other Expenses:

Interest expense on loans
Losses from selling assets
One-time unusual expenses

For most small businesses, this section is minor. But if you have significant debt, interest expense shows up here.

Net Income: The Bottom Line

Net Income = Operating Income + Other Income - Other Expenses

This is your profit (or loss) after everything. What remains to reinvest in the business, distribute to owners, or save.

Net Profit Margin

Net Profit Margin = (Net Income / Revenue) x 100

With $71,000 net income on $525,000 revenue: 13.5% net margin.

Meaning: For every dollar of revenue, you keep 13.5 cents as profit after all expenses.

Red Flags to Watch For

Revenue Growing, Profit Shrinking

If revenue increases but net income stays flat or declines, something is eating your growth. Check:

Is gross margin declining?
Are operating expenses growing faster than revenue?
Are you chasing unprofitable sales?

Volatile Gross Margin

Significant swings in gross margin month-to-month suggest:

Pricing inconsistency
Cost fluctuations
Production inefficiencies
Incorrect categorization of costs

Operating Expenses Exceeding Gross Profit

If your overhead costs more than your gross profit, you lose money on core operations. Either increase prices, reduce direct costs, or cut operating expenses. There’s no other math that works.

Owner Draws Missing from P&L

For sole proprietors and partnerships, owner draws aren’t expenses. They’re distributions of profit. If you “pay yourself” $80,000 through draws but show $71,000 profit, something is categorized wrong.

S-Corp owners should see their salary in operating expenses as payroll.

Questions to Ask Every Month

Is the business profitable? Start with net income. But don’t stop there.
What are the trends? Compare to last month. Compare to the same month last year. Compare to your budget.
Where is money going? Which expense categories are growing? Which are shrinking? Are changes intentional?
Is the margin healthy? Compare gross margin to industry benchmarks. Watch for decline.
Are operating expenses controlled? As revenue grows, expenses should grow more slowly. That’s economies of scale. If expenses grow faster, profitability erodes.

Making Your P&L Useful

A P&L is only valuable if it’s accurate and timely.

Accurate categorization: Expenses in the right categories. Consistent month over month.

Monthly close: Review within two weeks of month-end while details are fresh.

Comparative analysis: Prior year and budget comparisons side by side.

Consistent accounting: Same methods every period. No switching approaches mid-year.

If your P&L arrives six weeks late with questionable categorization, it’s history, not insight. You need current, clean data to make decisions.

The Story in Your Numbers

Your P&L isn’t just a compliance document. It’s a performance report. It tells you what’s working, what’s failing, and where to focus attention.

A Houston contractor who notices gross margin declining 2% per quarter can investigate before it becomes a crisis. A consultant who sees operating expenses growing faster than revenue can course-correct before profitability disappears.

The numbers are talking. Are you listening?

At EZQ Group, we prepare monthly financial statements for Houston businesses and walk owners through what the numbers mean. Clean books lead to clear P&Ls, and clear P&Ls lead to better decisions.

Ready to truly understand your numbers? Contact us to discuss your bookkeeping and financial reporting needs.