Understanding Your Profit and Loss Statement

By Terry Bennett · 27 October 2014 · Updated 23 March 2026

A profit and loss statement (also called a P&L or income statement) summarises your business revenue, costs, and expenses over a specific period to show whether you made a profit or a loss. In Xero, you can generate one from Accounting > Reports > Profit and Loss for any date range. It's the report that tells you whether your business model is actually working, and it's the first thing your accountant pulls when preparing your tax return

What is a profit and loss statement?

The P&L answers one question: did the business make money or lose money during this period? It does this by listing all revenue at the top, subtracting costs and expenses in layers, and arriving at a net profit or net loss at the bottom

It covers a period of time, not a point in time. That's the key difference from a balance sheet, which is a snapshot of a single date. Your P&L for January to March 2026 shows everything that happened across those three months. Your balance sheet on 31 March shows where you stood at close of business that day

How a profit and loss statement is structured

Every P&L follows the same basic flow, whether you're a sole trader or a company reporting under Australian Accounting Standards

Revenue (also called sales or turnover) sits at the top. This is the total income your business earned from its core activities during the period. If you're GST-registered, revenue is recorded excluding GST because the GST component isn't your income, it's collected on behalf of the ATO

Cost of goods sold (COGS) or direct costs come next. These are the costs directly tied to producing what you sell: materials, subcontractor labour, freight, manufacturing costs. For a service business, direct costs might be the wages of the people delivering the service. Subtract COGS from revenue and you get gross profit

Operating expenses (also called overheads or indirect costs) are everything else the business spends to operate: rent, utilities, insurance, admin salaries, marketing, accounting fees, software subscriptions. These costs exist whether you sell one unit or a thousand

Operating profit is what's left after subtracting operating expenses from gross profit. This is the number that tells you whether your core business operations are profitable before you account for interest, depreciation, or tax

Net profit is the final line after subtracting interest, depreciation, and income tax. This is the number that flows through to your balance sheet as retained earnings and the number your accountant uses for your tax return

Gross profit margin vs net profit margin

These two percentages tell you more about your business health than the raw dollar figures

Gross profit margin is gross profit divided by revenue. If your business does $800,000 in revenue with $320,000 in direct costs, your gross profit is $480,000 and your gross margin is 60%. This tells you how much of every dollar earned is left after covering the cost of delivery. If this number is shrinking, either your pricing is under pressure or your input costs are rising

Net profit margin is net profit divided by revenue. Same $800,000 in revenue, and after all expenses, interest, depreciation, and tax you're left with $120,000. That's a 15% net margin. This is the percentage of revenue that actually stays in the business or goes to the owners

Watching these margins over time matters more than watching the dollar figures. Revenue can grow 20% while net margin drops from 15% to 8% because overheads grew faster. The business looks bigger but the owners are keeping less

The other trap is the blended P&L. We had a construction client running several different business activities. The overall P&L showed a healthy profit. But when we broke it down by activity, one of them was consistently making a loss. The profitable activities were subsidising it, and the owners had no idea. A single-line P&L is like averaging the temperature across a house - the kitchen could be on fire and the average still reads comfortable. If your business has distinct revenue streams, you need to see margins by activity, not just in aggregate. Xero tracking categories make this straightforward once they're set up

How to read your P&L in Xero

Go to Accounting > Reports > Profit and Loss. Set your date range and run the report. The default view shows the current period, but the comparison view is where the real value sits. Set it to compare against the same period last year, or against the previous month, and Xero calculates the dollar and percentage change for every line

Three things to look at first. Is gross margin holding? If it's dropped more than a couple of points, something has changed in your pricing or cost structure. Are any single expense lines growing faster than revenue? That's the early signal that a cost is getting away from you. And is net profit converting to cash? If the P&L shows $50,000 profit but your bank balance hasn't moved, the cash flow statement will show you where the money went - usually receivables, inventory, or loan repayments

If you're reporting on accrual basis (most businesses should for their P&L), revenue includes invoices you've issued but haven't been paid yet. That means a profitable P&L doesn't guarantee cash in the bank. The two reports answer different questions

What your P&L doesn't show you

The P&L doesn't show asset purchases. If you bought a $60,000 vehicle, that cash left the business but it doesn't appear as an expense on the P&L. It's capitalised on the balance sheet and only hits the P&L gradually as depreciation over the asset's effective life. This is why a business can spend heavily on equipment, show a healthy profit, and still be short on cash

It doesn't show loan principal repayments either. The interest component of a loan repayment appears on the P&L as a finance cost, but the principal repayment is a balance sheet transaction. A business repaying $5,000 a month on a loan has $60,000 a year leaving the bank account that never touches the P&L

And it doesn't show owner drawings. In a sole trader or partnership, drawings are not an expense. They reduce equity on the balance sheet. A business owner drawing $150,000 a year might show $200,000 profit on the P&L and wonder where the money went. $150,000 of it went to them

Common P&L mistakes in small business

Coding personal expenses to business categories. A family dinner coded to "entertainment," a personal subscription coded to "software." It inflates expenses, understates profit, and creates a problem if you're ever audited. These should sit in a drawings or director's loan account

Not separating direct costs from overheads. This one is structural and it costs people visibility for years. If everything sits in one undifferentiated expense bucket, you can't calculate gross margin. You can't tell whether your pricing covers your delivery costs. You can't compare the profitability of different jobs, projects, or service lines. Setting up your Xero chart of accounts with a clear COGS section is one of the first things worth getting right, and one of the hardest things to fix retrospectively because it means recoding historical transactions

Running the P&L on cash basis for management reporting. Cash basis is fine for your BAS, but for understanding business performance you want accrual. Otherwise a $50,000 invoice paid in January inflates January's revenue and makes February look flat, even though the work was done evenly across both months

P&L structure and reporting standards referenced in this article are consistent with Australian Accounting Standards, current as at March 2026

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Terry Bennett

CPA with thirty years and a knack for the tricky stuff - Xero conversions, fixed assets, and accounting problems that make other people's eyes glaze over. Terry does the job right the first time, then heads to the golf course

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Common questions

Gross profit is revenue minus direct costs (the costs of producing what you sell). Net profit is what remains after also subtracting operating expenses, interest, depreciation, and income tax. Gross profit tells you whether your pricing covers your delivery costs. Net profit tells you what the business actually keeps.

Profit and cash are calculated differently. The P&L includes revenue from invoices not yet paid (on accrual basis), excludes asset purchases and loan principal repayments, and does not show owner drawings. A business can be profitable on the P&L while cash is tied up in receivables, inventory, equipment purchases, or debt repayments. The cash flow statement explains the gap.

For management reporting and understanding business performance, accrual basis is recommended. It matches revenue to the period it was earned and expenses to the period they were incurred, giving you an accurate picture of profitability. Cash basis is appropriate for BAS (GST reporting) but can distort your P&L by shifting revenue and expenses between periods based on payment timing.

Use Xero tracking categories. Set up a tracking category for each business activity or revenue stream, then assign it to transactions as they are coded. You can then run the Profit and Loss report filtered or grouped by tracking category to see margins for each activity separately, rather than only seeing a blended total.

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