A profit and loss statement shows a business's income and expenses for a period and the resulting profit or loss. For a trading business it starts with sales, subtracts cost of goods sold (opening stock + purchases + direct costs − closing stock) to get gross profit, then subtracts operating expenses, depreciation, interest and tax to reach net profit. GST collected is not income and is excluded.
A profit and loss statement (P&L) answers the question every owner asks: did the business make money this period, and where did it go? It lists income and expenses over a period — a month, a quarter or a financial year — and arrives at profit or loss. This guide explains the structure, how stock and GST affect it, and walks through a complete example for a small trading business.
What is a profit and loss statement?
A P&L summarises performance over a period. That makes it different from a balance sheet, which is a snapshot of what the business owns and owes on one date. The Companies Act 2013 includes the statement of profit and loss in its definition of financial statements, and companies follow the format in Schedule III. Proprietors and firms are not bound by Schedule III, but the logic is identical.
It is built from the income and expense ledgers in your books — the nominal accounts described in double-entry bookkeeping basics.
What are the parts of a P&L?
| Section | What it includes | Result |
|---|---|---|
| Revenue from operations | Sales of goods and services (net of returns, excluding GST) | |
| Cost of goods sold | Opening stock + purchases + direct expenses − closing stock | |
| Gross profit | ||
| Operating expenses | Salaries, rent, electricity, marketing, software, travel | |
| Operating profit (EBITDA, before depreciation) | ||
| Depreciation | Wear and tear on equipment, furniture, vehicles | |
| Finance costs | Interest on loans and overdraft | |
| Other income | Interest received, discount received, scrap sale | |
| Profit before tax | ||
| Tax expense | Income tax for the period | |
| Net profit (profit after tax) |
Proprietors often show the first part separately as a trading account (sales, COGS, gross profit) and the rest as the profit and loss account.
How do you calculate cost of goods sold?
For a trader:
COGS = Opening stock + Purchases (net of returns) + Direct expenses − Closing stock
Direct expenses are costs of getting goods into saleable condition and location: inward freight, loading and unloading, and packing needed before resale. Under AS 2, inventory cost includes purchase price and directly attributable costs, and excludes taxes recoverable from the authorities.
Closing stock is the big judgment item. It must be counted and valued at the lower of cost and net realisable value. Overvalue it and profit is overstated; undervalue it and profit is understated. See stock valuation methods for FIFO and weighted average, and inventory management basics for counting.
How does GST affect the P&L?
For a regular GST-registered business:
- Sales are shown at taxable value. Output GST is a liability, not income.
- Purchases and expenses are shown net of input tax credit you can claim.
- Blocked or ineligible GST is added to the related cost or expense.
- Late fees and interest on GST are expenses; interest is usually shown under finance costs or other expenses as your accountant advises.
For a composition taxpayer, who cannot collect GST from customers or claim credit, the tax paid on turnover is a business expense, and purchase GST forms part of cost.
Worked example: a Nashik electrical goods shop (FY 2025-26)
A Nashik electrical goods shop is a regular GST taxpayer. All figures are excluding GST.
Trading data
- Opening stock (1 April 2025): ₹4,20,000
- Purchases: ₹38,50,000
- Purchase returns: ₹50,000
- Inward freight: ₹65,000
- Sales: ₹48,30,000
- Sales returns: ₹30,000
- Closing stock (31 March 2026, at lower of cost and NRV): ₹5,10,000
Expenses
- Salaries: ₹4,80,000
- Shop rent: ₹2,40,000
- Electricity and internet: ₹78,000
- Marketing and printing: ₹45,000
- Billing software and accounting fees: ₹36,000
- Depreciation on furniture and computers: ₹40,000
- Interest on overdraft: ₹62,000
- Interest received on fixed deposit: ₹18,000
Step 1: Net sales
₹48,30,000 − ₹30,000 = ₹48,00,000
Step 2: COGS
| ₹ | |
|---|---|
| Opening stock | 4,20,000 |
| Add: purchases (38,50,000 − 50,000) | 38,00,000 |
| Add: inward freight | 65,000 |
| Less: closing stock | (5,10,000) |
| COGS | 37,75,000 |
Step 3: Gross profit
₹48,00,000 − ₹37,75,000 = ₹10,25,000 (gross margin 21.35%)
Step 4: Operating expenses
4,80,000 + 2,40,000 + 78,000 + 45,000 + 36,000 = ₹8,79,000
Operating profit before depreciation = ₹10,25,000 − ₹8,79,000 = ₹1,46,000
Step 5: Depreciation, finance cost and other income
₹1,46,000 − ₹40,000 − ₹62,000 + ₹18,000 = ₹62,000 profit before tax
Income tax depends on the owner's status and regime, so it is not computed here; ask your accountant.
What the example tells the owner
- The shop earns ₹21.35 on every ₹100 of sales before overheads. Understanding that percentage versus the markup the shop applies is covered in gross margin vs markup.
- Overheads consume ₹8.79 lakh of the ₹10.25 lakh gross profit. Salaries and rent alone are ₹7.2 lakh.
- Interest of ₹62,000 wipes out half of what remains. Reducing stock or debtors to cut the overdraft is a real lever.
- If closing stock had been overstated by ₹1,00,000 (say, obsolete fittings still valued at cost), profit before tax would have shown ₹1,62,000 — more than double the true figure.
How do you prepare a P&L step by step?
- Close the period's transactions: all sales invoices, purchase bills, credit and debit notes entered.
- Reconcile bank and cash to statements and counts.
- Reconcile GST ledgers so that tax is fully separated from income and expenses.
- Count and value closing stock at the lower of cost and NRV.
- Book adjustments: outstanding expenses (rent due, salary payable), prepaid expenses, accrued income, depreciation, bad debts.
- Run the trial balance and check it tallies.
- Prepare the P&L in a consistent format and compare with the previous period.
- Review ratios: gross margin, expense-to-sales, net margin.
At financial year end these steps form part of a wider close; see the year-end closing checklist.
Which P&L ratios should a small business track?
| Ratio | Formula | Example (above) |
|---|---|---|
| Gross margin | Gross profit ÷ Net sales | 10,25,000 ÷ 48,00,000 = 21.35% |
| Operating expense ratio | Operating expenses ÷ Net sales | 8,79,000 ÷ 48,00,000 = 18.31% |
| Net margin (before tax) | Profit before tax ÷ Net sales | 62,000 ÷ 48,00,000 = 1.29% |
| Stock turnover | COGS ÷ Average stock | 37,75,000 ÷ 4,65,000 ≈ 8.1 times |
Average stock here is (4,20,000 + 5,10,000) ÷ 2 = ₹4,65,000. A rising stock turnover means goods sell faster and less cash sits on shelves.
What adjustments change the P&L at period end?
Raw ledger balances rarely give the right profit. Accrual accounting means income and expenses belong to the period they relate to, not the period in which cash moved. The common adjustments are:
| Adjustment | Example | Effect on profit |
|---|---|---|
| Outstanding expense | March electricity bill received in April | Reduces profit (expense added) |
| Prepaid expense | Annual insurance paid in January for 12 months | Increases profit (unexpired part carried forward) |
| Accrued income | Interest earned but not yet credited | Increases profit |
| Income received in advance | Customer advance for goods not yet supplied | Not income yet; shown as a liability |
| Depreciation | Furniture, computers, vehicles | Reduces profit |
| Bad and doubtful debts | Customer unlikely to pay | Reduces profit |
| Closing stock write-down | Damaged or obsolete goods | Reduces profit |
Worked example: prepaid insurance
The Nashik shop paid ₹24,000 on 1 January 2026 for shop insurance covering January to December 2026. By 31 March, only three months have expired.
- Expense for FY 2025-26 = ₹24,000 × 3 ÷ 12 = ₹6,000
- Prepaid (carried to next year as an asset) = ₹18,000
Charging the full ₹24,000 would have understated this year's profit by ₹18,000 and overstated next year's by the same amount.
Monthly P&L for management
A monthly P&L uses the same structure but needs a closing stock figure every month. Few small businesses count monthly, so they estimate it from the stock register (book stock) and confirm with a full count at year end. If your billing and stock records agree, book stock is a reasonable monthly estimate; if they do not, monthly profit will swing for reasons that have nothing to do with trading. Compare each month with the same month last year rather than the previous month, especially in seasonal trades.
Why can a profitable business still run short of cash?
The P&L records income when it is earned and expenses when they are incurred, not when money moves. So a P&L profit and the bank balance can move in opposite directions.
Suppose the Nashik shop's profit of ₹62,000 includes depreciation of ₹30,000, and during the year its debtors rose by ₹1,50,000 and its stock by ₹80,000:
| Item | Effect on cash |
|---|---|
| Profit before tax | +₹62,000 |
| Add back depreciation (no cash paid) | +₹30,000 |
| Increase in debtors | −₹1,50,000 |
| Increase in stock | −₹80,000 |
| Cash from operations | −₹1,38,000 |
The shop made a profit but used ₹1,38,000 of cash, mostly by extending credit and buying stock ahead of sales. Reading the P&L next to a debtor ageing report and the stock register explains the gap; see cash flow management for small businesses.
Common mistakes
- Including GST in sales or purchases, inflating both and distorting margins.
- Guessing closing stock instead of counting and valuing it.
- Expensing capital purchases like a new computer instead of depreciating them.
- Mixing personal expenses of the owner with business expenses.
- Ignoring outstanding expenses, such as December rent paid in January for a December P&L.
- Recording customer advances as sales before the goods are supplied.
- Comparing months with different stock methods, which makes trends meaningless.
Key takeaways
- The P&L covers a period; the balance sheet covers a date.
- Net sales − COGS = gross profit; gross profit − expenses = net profit.
- COGS depends on closing stock, valued at the lower of cost and NRV.
- Keep GST out of income and expenses unless it is non-recoverable.
- Prepare it monthly for management, not just yearly for tax.
- Billing and inventory records that agree with each other make the P&L fast and reliable — Billing Software by Betterwork's reports, for example, give sales and tax figures straight from invoices.
This guide is general information, not tax advice. Rules last checked on 20 October 2026; confirm with your tax professional for your situation.