The income statement walks from revenue to net income, subtracting costs and taxes along the way. Each line is named, each layer of profit means something different, and an analyst's job is to know which layer to use for which question.
The structure
Revenue− Cost of revenue (COGS)= Gross profit− Operating expenses (SG&A, R&D, etc.)= Operating income (EBIT)− Interest expense (+ interest income)= Pre-tax income− Tax expense= Net income
Revenue
What customers paid for goods and services delivered. Not what they ordered, not what they were billed — what was delivered. The revenue recognition rules (ASC 606 in GAAP, IFRS 15) are the most consequential accounting standard of the last decade. They determine when 'a sale' becomes revenue, which can shift quarters by quarters.
Bookings vs revenue
A SaaS contract signed for $1.2M over 12 months is a $1.2M booking but only $100k of revenue per month. Confusing the two is how startups inflate growth numbers. The income statement only counts the latter.
Gross profit
Revenue minus the direct cost of producing the good or service. For a software company, that's mostly hosting and customer support. For a manufacturer, raw materials and factory labor. Gross margin (gross profit ÷ revenue) tells you how much pricing power the business has.
- Software/SaaS: 70-90% gross margin
- Hardware: 30-50%
- Retail: 20-40%
- Commodity producers: 10-20%
- Investment banks: structurally different — closer to 'compensation ratio'
Operating income (EBIT)
Gross profit minus operating expenses (SG&A, R&D, marketing). EBIT measures what the business produces from its operations, before financing decisions and taxes. It's the level at which you compare two businesses regardless of how they're capitalized — a debt-funded company and an equity-funded company should be compared at EBIT, not net income.
Net income
After interest and taxes. The bottom line. The number that drives EPS. But also the most distorted by one-time items, tax-rate quirks, and capital structure — which is why analysts often use EBIT or EBITDA for cross-company comparisons.
EBITDA — proceed with care
EBITDA = EBIT + Depreciation + Amortization. Useful for capital-intensive businesses where D&A is large but non-cash. Misleading when companies use it to ignore real expenses (stock-based compensation is real; capex you ignored is real).
Common patterns to flag
- Revenue growing faster than gross profit → margin pressure
- Operating income flat while net income grows → tax engineering or interest-rate luck
- Big 'restructuring' or 'impairment' charges every year → not actually one-time
- Operating income negative but adjusted EBITDA positive → ask what's being adjusted out
Exercise
A company reports revenue $1B, COGS $400M, OpEx $300M, Interest expense $50M, Tax expense $60M. Compute gross profit, gross margin, operating income, operating margin, and net income.