What to take away
- Read the income statement from revenue down: gross profit, operating income, earnings before taxes, then net income.
- Convert lines into percentages of revenue so you can compare periods and spot cost creep.
- Profit is not cash and not taxable income, so read the P&L beside the balance sheet and your cash position.
What an income statement covers
An income statement reports revenue, expenses and the profit or loss that remains for a defined period: a month, a quarter, a half-year or a fiscal year. It often shows at least one earlier period beside the current one so you can compare. The balance sheet, by contrast, is a snapshot at a single date; our guide to reading a balance sheet covers that statement.
Check the period before anything else. A three-month report set beside a twelve-month report tells you nothing useful, and a seasonal business will look very different in January than in July. Also confirm that the report is complete. If supplier bills or payroll for the period have not been entered, profit is overstated.
Read it from the top down
Most statements follow the same order. Revenue, or sales, is what the business earned from its core activity. Cost of goods sold, cost of sales or cost of services comes next: the direct costs of producing what you sold, such as materials and direct labour for a manufacturer, or the purchase cost of goods for a retailer. Revenue less that cost is gross profit.
Below that sit operating expenses, the indirect costs of running the business: rent, utilities, marketing, insurance, office supplies, repairs, benefits, and accounting and legal fees. Gross profit less operating expenses is operating income. Then come non-operating items, such as interest or a one-time gain on selling an asset, which lead to earnings before taxes. Subtract income taxes and you reach net income, also called net profit.
A worked example with illustrative numbers
Imagine a small services business with $200,000 of revenue in a year and $60,000 of direct costs, such as subcontractors and materials. Gross profit is $140,000. Operating expenses of $95,000 leave operating income of $45,000. Interest expense of $5,000 on a loan brings earnings before taxes to $40,000. If income tax is $6,000, net income is $34,000. These numbers are for illustration only and are not a benchmark for any industry.
Notice how much the middle lines tell you. A business can show a healthy gross profit and still earn little if operating expenses have crept up. Equally, a business with a loss at the bottom may have a sound core operation that was dragged down by a one-time cost. The bottom line alone cannot say which.
Turn the lines into margins
Margins express each profit line as a percentage of revenue, which makes periods and years comparable even when sales change. Gross margin is gross profit divided by revenue: $140,000 over $200,000 is 70% in the example. Net profit margin is net income divided by revenue: $34,000 over $200,000 is 17%.
BDC also describes vertical analysis, where you express each cost as a share of revenue, and time series analysis, where you compare each line with earlier years. Use these to ask why. If materials rose from 26% to 29% of revenue, did prices to customers lag supplier increases, or was waste the cause? Sora’s profit margin and break-even tools can help you test simple what-if numbers, and the pricing article on this site looks at setting prices for margin.
Why profit is not the same as cash
Under the accrual method, which the CRA says business income generally has to follow, you report income in the period you earn it and deduct expenses in the period you incur them, whether or not money has changed hands. A $10,000 invoice sent in March belongs in March revenue even if the customer pays in May. Some farmers, fishers and commission agents may use the cash method instead.
This is why the income statement and your bank balance can disagree. Loan principal repayments, equipment purchases and owner withdrawals use cash but do not appear as operating expenses. Amortization is the opposite: it reduces profit without any cash leaving. For the full picture, read the P&L alongside the balance sheet and a cash forecast, and see our article on why profitable businesses run short of cash.
Common traps when reading a P&L
Miscategorized costs are the most frequent problem. If a direct cost is booked as an operating expense, gross margin looks better than it is; if personal spending is booked in the business, profit is understated and the report is harder to defend. Look at large lines labelled miscellaneous or uncategorized, and ask what is inside them.
Other traps include one-time items that distort a single period, revenue recorded before the work is done, missing year-end accruals and comparing unlike periods. Accounting profit is also not taxable income. Tax rules adjust some items, so avoid estimating a tax bill by applying a rate to an unfinished P&L.
A monthly routine that works
Set aside time after each month-end close. Confirm the books are reconciled, then read from revenue to net income. Compare with the same month last year and with the prior month, and write down any line that moved more than you expected. Pair it with the aged receivables list so you can see whether sales are turning into cash.
Keep the questions short. What changed? Is it timing, a one-off or a trend? What action follows? That discipline matters more than a long dashboard, and it fits neatly into a quarterly review, which this site also covers.
What to bring to your accountant or lender
Bring the income statement for the current period and at least one earlier period, the matching balance sheet and the chart of accounts if you have changed categories. Add notes on unusual transactions and anything you expect next period. If you are applying for financing, a lender is likely to want statements prepared consistently over several periods.
Ask your accountant which costs belong in gross profit, which year-end adjustments are still to come and how accounting profit will differ from taxable income for the period. The answers depend on your structure and your records, so treat the example above as a way of learning the layout, not as advice for your own situation.
Sources & editorial notes
Sources checked October 24, 2026. The examples are illustrative and provide general information. Discuss how the guidance applies to your circumstances with your accountant.
- What is an income statement?BDC
- Accounting for your earningsCanada Revenue Agency
- What is a balance sheet?BDC
Rules and guidance can change. Use the current official source and confirm the treatment for your facts. To flag an error, contact Sora.