The income statement is one of the most essential documents you’ll encounter, whether you’re looking to invest, assess a company’s performance, or understand how businesses measure success.
It’s one of the three primary financial statements that investors, analysts and other professionals use.
But what is it, why does it matter, and what components make it up?
This is the first article in our Income Statement Series. Expand here for the others.
What Is The Income Statement
The income statement, or statement of profit or loss, provides an overview of a company’s financial performance over time. It shows the total:
- Revenue – how much it earned
- Expenses – how much it spent
- Profit – how much revenue is kept after deducting expenses
The income statement is a window into a company’s financial engine and a key source for calculating metrics.
Why It Matters
Understanding the income statement isn’t just for accountants. It serves different purposes for different users.
For Investors
The income statement helps investors:
- Track revenue growth and cost management
- Assess how much profit a company is generating
- Compare companies against their industry competitors
- Evaluate earnings consistency and long-term profitability
Fundamental investor metrics like earnings per share (EPS) and operating margin are calculated using this statement.
For Lenders
Banks and other lenders use the income statement to:
- Identify trends that impact creditworthiness
- Assess whether a company can cover its debt obligations
- Understand if profits are stable, growing or declining over time
The income statement is often reviewed alongside the balance sheet and cash flow statement in credit risk analysis.
For Students & Future Analysts
Mastering the income statement builds the foundation for:
- Equity research and valuation
- Financial analysis and modelling
- Budgeting and internal decision-making
Understanding financial statements is essential for anyone interested in finance, accounting and business management.
Reporting Periods
An income statement shows financial performance over time, and companies report results for different time frames.
Quarterly Income Statements
Every public company (those traded on the stock market) releases earnings reports every three months. These quarterly reports (Q1, Q2, Q3, Q4) update analysts and shareholders on a company’s short-term progress and seasonal trends.
Trailing Twelve Months (TTM) Income Statements
These income statements provide an overview of the four most recent quarters. These offer the most up-to-date performance summary without waiting for a company’s annual report.
Annual Income Statements
Annual income statements show the bigger picture. They combine the four quarters within a company’s fiscal year to help assess overall strategy execution and long-term profitability.
Fiscal Year vs Calendar Year
Some companies follow a calendar year (January to December) with their financial reporting, while others use a fiscal year that aligns with their business cycles.
Microsoft (June year-end) and Apple (September year-end) are two companies that use fiscal years in their financial reporting. Alphabet (Google’s parent company) and Meta Platforms use calendar years.
Income Statement Formula
At its core, the income statement is governed by this equation:
Net Income = Revenue – Expenses
But that’s like saying a car works by moving forward, ignoring that plenty is happening under the hood.
Breaking up expenses into its components gives a more expanded view of the formula:
Net Income = Revenue – COGS – Operating Expenses – Interest – Taxes
Each element in that equation tells a different part of the company’s financial performance story.
Structure & Components (Line-by-Line)
Here’s a breakdown of each component and what it represents in an income statement.
Revenue
Revenue, sometimes called the top line, is the total income generated from selling goods and services. In profitable companies, it’s the largest figure on their income statement.
Revenue is calculated by multiplying the quantity of goods and services sold by the price per good and service. So, if Microsoft sells:
- 10,000 computers for £1,000 each (the good)
- With an accompanying Microsoft 365 £100 annual subscription (the service)
- Its revenue would be £11,000,000
Cost of Goods Sold (COGS)
For companies that sell physical products, COGS represent the costs of making them. It reflects the total costs of raw materials, labour and manufacturing.
For purely software companies, think Visa, COGS is called cost of revenue.
Gross Profit
Gross profit is the first of several profit figures on an income statement. It is calculated by:
Gross Profit = Revenue – COGS
Gross profit shows how efficiently a company turns direct inputs (COGS) into profit.
Operating Expenses
Often called Opex, operating expenses represent all the costs required to run the business. It includes:
- Selling, General & Admin (SG&A) Expenses: salaries, utilities and other office expenses
- Research & Development (R&D) Expenses: most common in technology and pharmaceutical companies
- Depreciation & Amortisation (D&A): non-cash expenses reflecting the reduction in an asset’s value over time
Operating expenses are the costs that keep a company’s lights on and its doors open.
Operating Profit
Operating profit, sometimes called Earnings Before Interest and Taxes (EBIT), reflects a company’s core profitability. It’s the second profit figure in an income statement and tells investors how well a company performed based only on its operating activities.
It is calculated as:
Operating Profit = Gross Profit – Operating Expenses
Non-Operating Items
This includes the income and expenses unrelated to a company’s core operations. It usually comprises:
- Interest expenses for taking on debt
- Interest income from cash and short-term investments
- Gains or losses on the disposal of business assets
Depending on the company, interest income and interest expenses can be presented as one figure, net interest expense.
Profit Before Tax (PBT)
Profit before tax represents a company’s total earnings before Mr Taxman takes his share.
Profit Before Tax = Operating Profit ± Non-Operating Items
PBT is usually the third profit figure in an income statement. But if a company has zero non-operating items, its income statement will go from operating profit to net profit (after accounting for taxes).
Income Tax
Income taxes represent a percentage of a company’s PBT that goes to the government. If Apple earns profits before tax of $1,000,000 and the US corporate tax rate is 19%, the company’s tax bill would be $190,000.
Net Profit (Profit After Tax)
Net profit, often called the bottom line, is the final profit figure on an income statement. It reflects the total revenue retained after accounting for all business expenses.
Net Profit = PBT – Income Tax
Earnings Per Share (EPS)
EPS displays a company’s net profit on a per-share basis, telling investors how much profit is attributed to each share of stock.
EPS = Net Income ÷ Weighted Average Shares Outstanding
Two EPS figures appear on an income statement, each with a different meaning and significance to investors.
- Diluted EPS includes the impact of stock options and warrants. Due to this, it’s usually lower than Basic EPS.
- Basic EPS doesn’t include the impacts of dilution.
Diluted EPS is most used because it better reflects the earnings per share of stock an investor owns.
Advanced Income Statement Concepts
Want to take your learning up a notch? Here are two more nuanced items that are derived from the income statement.
EBITDA
EBITDA stands for Earnings Before Interest Tax Depreciation and Amortisation.
EBITDA = Operating Profit (EBIT) + Depreciation & Amortisation (D&A)
EBITDA evaluates a company’s operational efficiency without the noise of financing costs and accounting choices. However, it should be used with caution. If companies adjust it to mask weak profits, it can be misleading.
Adjusted EPS
Companies sometimes present earnings that strip out certain items to provide a clearer view of performance. Because of this, you should be sceptical – always dig deeper and understand what was excluded and why.
Rounding It All Up!
The income statement is your starting point for understanding how a business earns and spends money. It tells a story of performance, profitability and strategy.
Mastering it will help you:
- Make smarter investment decisions
- Perform stronger financial analyses
- Build the foundation for deeper accounting and valuation skills
Want to go further? Pair this with the balance sheet and cash flow statement for a complete financial picture.
