How businesses record income, costs and profit — and how to read and interpret a P&L statement.
A Profit & Loss (P&L) account (also called an income statement) is a financial document that summarises a business's income and costs over a specific period — usually one year. It shows whether the business made a profit or a loss.
| Term | Definition |
|---|---|
| Revenue / Turnover | Total income from sales before any costs are deducted |
| Cost of Sales (COGS) | Direct costs of producing the goods sold (materials, direct labour) |
| Gross Profit | Revenue − Cost of Sales |
| Expenses / Overheads | Indirect costs not tied to production (rent, admin, marketing) |
| Net Profit | Gross Profit − Expenses (before tax) |
| Net Profit after Tax | Net profit minus corporation tax |
A P&L account follows a standard format. Here is a worked example for "Bright Spark Electronics Ltd":
Revenue − Cost of Sales
£500,000 − £200,000 = £300,000
Shows profit from core trading before overhead costs.
Gross Profit − Expenses
£300,000 − £155,000 = £145,000
Shows overall profitability after all costs are deducted.
Reading the numbers is not enough — you must interpret what they mean for the business's health and prospects.
This shows how efficiently the business turns sales into gross profit. A higher GPM means the business keeps more from each pound of revenue after direct costs.
Example: GPM = (£300,000 ÷ £500,000) × 100 = 60% — for every £1 of sales, 60p becomes gross profit.
This shows overall profitability after all costs. A higher NPM means the business is managing overheads efficiently.
Example: NPM = (£145,000 ÷ £500,000) × 100 = 29% — for every £1 of sales, 29p becomes net profit before tax.
A single year's P&L is more meaningful when compared to previous years or industry benchmarks. Look for:
It is possible to be profitable but have cash flow problems. A business may record profit on paper but still run out of cash if customers haven't paid yet, or if money is tied up in stock. This is why both P&L and cash flow statements are needed.
A business can improve its profit in two fundamental ways: increase revenue or reduce costs.
| To Improve… | Target These Costs | Methods |
|---|---|---|
| Gross Profit | Cost of Sales (direct costs) | Cheaper suppliers, reduce material waste, better production efficiency |
| Net Profit | Overheads (indirect costs) | Cut rent (relocate), reduce staff costs, lower marketing spend |
Cutting costs can have unintended consequences. Reducing marketing spend saves money short-term but may reduce sales. Using cheaper materials may cut cost of sales but damage product quality and reputation. Businesses must consider the long-term impact of any cost-cutting decisions.
Click a term on the left, then its correct definition on the right.
Gross Profit = Revenue − Cost of Sales. Net Profit = Gross Profit − Expenses. These must be memorised precisely — and you may be asked to calculate either in the exam.
GPM (%) = (Gross Profit ÷ Revenue) × 100. NPM (%) = (Net Profit ÷ Revenue) × 100. Always show your working and express as a percentage.
If you calculate a profit margin, say what it means: "A net profit margin of 29% means the business retains 29p of every £1 of revenue as profit after all costs — this is a healthy margin in retail."
One year's figures tell you little in isolation. Always compare to previous years or ask whether margins are improving or declining — and explain why.
Remember: a profitable business can still run out of cash. This is a key distinction examiners love. Profit is accrual-based; cash is what's actually in the bank.