How to Read a Profit and Loss Account

To read a profit and loss account, start at the top with turnover and work down: each line deducts a type of cost until you reach the profit (or loss) the business made for the period. The key figures to look at are gross profit, operating profit and profit after tax, and how each one compares with last year. This guide walks through every line in plain English, shows a worked example for a small limited company, and explains what the numbers can and cannot tell you.

Key takeaways

• The profit and loss account shows performance over a period; the balance sheet shows position at a date.
• Gross profit tells you whether your pricing covers direct costs.
• Operating profit shows whether the business as a whole is paying its way.
• Profit is not cash: timing, loans and asset purchases all create differences.
• Dividends are paid out of profit after tax; they are not an expense.

What is a profit and loss account?

A profit and loss account (P&L), also called an income statement, summarises a business's income and expenses over a period, usually its financial year. It forms part of a limited company's annual accounts, alongside the balance sheet and notes. GOV.UK explains what annual accounts must contain and which parts small companies need to file. Many owners also receive a P&L monthly or quarterly as part of their management accounts.

The lines of a profit and loss account, in order

1. Turnover (sales or revenue). The value of goods and services sold in the period, excluding VAT if you are VAT registered.
2. Cost of sales. Costs that rise and fall directly with sales, such as materials, stock sold and subcontractor labour.
3. Gross profit. Turnover minus cost of sales. Divide by turnover to get your gross margin percentage.
4. Administrative expenses (overheads). Running costs that do not move directly with sales: rent, salaries, insurance, software, accountancy and depreciation.
5. Operating profit. Gross profit minus overheads, plus any other operating income.
6. Interest. Interest paid on loans and overdrafts, or received on deposits.
7. Profit before tax. The profit on which the tax charge is based, after adjustments for tax rules.
8. Tax on profit. The corporation tax charge for the period.
9. Profit after tax. What is left for the shareholders, which can be paid as dividends or kept in the company.

P&L, balance sheet and cash flow compared

For the other half of the picture, read our guide on how to read a company balance sheet.

Worked example (illustrative example)

Illustrative example only, not a real company. A one-director IT consultancy limited company has the following simplified profit and loss account for its year ended 31 March 2026:

• Turnover: £96,000
• Cost of sales (subcontractors): £18,000
• Gross profit: £78,000 (a gross margin of about 81%)
• Administrative expenses, including the director's salary, software, insurance and accountancy: £21,000
• Operating profit: £57,000
• Interest payable: £0
• Profit before tax: £57,000

The corporation tax charge is then worked out on taxable profit, not simply on the £57,000; check the current Corporation Tax rates and marginal relief rules on GOV.UK. Profit after tax is what the director, as shareholder, can draw as dividends. Comparing with the previous year, the director notices subcontractor costs have doubled while turnover rose only 10%, so the gross margin has fallen. That is the kind of insight the P&L is for.

Checklist: questions to ask of your P&L

• Has turnover grown, and is the growth from more work or higher prices?
• Has the gross margin percentage held steady compared with last year?
• Which overheads have risen fastest, and are they still needed?
• Is there any unusual one-off income or cost distorting the result?
• Does profit after tax support the dividends you plan to pay?
• Does the profit match what you see in the bank once timing is considered?

Common mistakes

• Confusing profit with cash. Unpaid invoices count as sales, and loan repayments do not count as costs.
• Paying dividends from turnover. Dividends can only be paid out of available profits; see salary vs dividends.
• Treating asset purchases as expenses. A laptop or van goes on the balance sheet and is depreciated, rather than hitting the P&L in one go.
• Assuming every cost is tax-deductible. Some costs appear in the P&L but are disallowed for tax; see our guide to allowable expenses.
• Looking at one year in isolation. Trends matter more than a single figure.

How we can help

We are a London-based specialist accounting practice with fixed fees. Our company accounts service starts from £350 per year, corporation tax returns from £250 per year, and limited company packages from £75 per month. We prepare your accounts and walk you through what your P&L means for your business. See our company accounts service, check our pricing, or contact us.