Your bank balance and your profit are not the same thing

If you run a small firm, the bank balance is usually the number you check first. It is immediate, it is real, and it tells you whether you can pay the wages on Friday. But it will not tell you whether your business is actually making money. That is the job of the profit and loss statement — the P&L, sometimes called the income statement.

A P&L covers a period: a month, a quarter, a year. It matches the sales you made in that period against the costs you incurred to make them, whether or not the cash has moved yet. A profitable month can leave your current account looking thin if a big customer is paying on 60-day terms. A loss-making month can leave it looking healthy if a VAT repayment or a loan landed. Both statements are true. They are just answering different questions.

Revenue: what the top line really measures

Revenue — your turnover — is the value of work you invoiced in the period, net of VAT and net of any credit notes. Not the money that arrived in the bank. If you raised a £12,000 invoice in March and it is paid in May, the revenue belongs in March.

This distinction matters more than most owners expect. A few things worth looking at each time you review the top line:

• Recurring versus one-off. If a strong month was driven by a single large job, do not plan next month's overheads around it.
• Credit notes and refunds. These should be netted off, not quietly buried. A rising level of credit notes often points to a delivery or quality problem.
• Concentration. If one client is more than a quarter of your revenue, your P&L is only as stable as that relationship.

Direct costs and the gross profit line

Direct costs — cost of sales, in accountant's language — are the costs that rise and fall with the work you do. For a product business that means stock, materials, packaging and inbound freight. For a service business it is usually subcontractors, associates, and the delivery staff whose hours are tied to client projects.

Subtract direct costs from revenue and you get gross profit. Divide gross profit by revenue and you have your gross margin, expressed as a percentage. This is one of the most useful numbers in a small business, because it tells you what each pound of sales actually contributes before the fixed costs are paid.

If your gross margin is 40 per cent, then £100 of sales leaves £40 to cover rent, insurance, your own salary and everything else. If it slips to 30 per cent, you need a third more sales to stand still. Margin drift is quiet — a supplier increase absorbed without repricing, a discount given to win a job — but it compounds quickly.

Overheads: the costs that do not care how busy you are

Overheads, or fixed costs, are the ones that turn up whether you sold anything or not: premises, utilities, insurance, software subscriptions, marketing, accountancy fees, and the admin salaries that keep the place running.

Subtract overheads from gross profit and you reach operating profit — the clearest single measure of whether your core trading activity is genuinely profitable. Below that line you may find interest on loans, depreciation and one-off items, and then tax. Those matter, but they are not a verdict on how well you trade.

Two habits help here. First, review subscriptions and renewals once a quarter; small monthly charges accumulate into a serious overhead without anyone ever deciding to spend the money. Second, track overheads as a percentage of revenue over time. If revenue falls and overheads stay flat, the squeeze is immediate.

Reading the statement, not just the last line

A P&L with a healthy bottom line can still be hiding trouble. Compare the current period to the same period last year and to your budget, then ask three questions:

• Is revenue growing faster than gross profit? If revenue is rising while gross profit lags, you are buying sales rather than earning them.
• Are overheads growing faster than revenue? A little growth is normal; sustained drift is not.
• Is anything in this period genuinely one-off — a legal cost, an equipment write-off, a large bad debt?

A rolling twelve-month view smooths out seasonal peaks and quiet patches, which matters in the UK if your trade is tied to the school year, the weather or a particular quarter.

A simple monthly routine

You do not need a finance department. You need twenty minutes, once a month, ideally within a fortnight of the period ending while the detail is still fresh.

• Check three figures: revenue, gross margin percentage, and operating profit.
• Compare them to last month, the same month last year, and your budget.
• Investigate any movement of more than a few percentage points before you move on.
• Note what you changed as a result. Over a year, those notes become your management commentary — and a useful starting point for your accountant at year end.

Read your P&L this way and it stops being a document you file and starts being the most honest conversation you can have about your business.