The Income Statement

The Income Statement Waterfall

The income statement (P&L) measures performance over time, unlike the balance sheet's snapshot. It flows as a waterfall from top line to bottom line.

$$\text{Revenue} - \text{COGS} = \text{Gross profit}$$ $$\text{Gross profit} - \text{OPEX} = \text{EBIT}$$ $$\text{EBIT} - \text{Interest} - \text{Tax} = \text{Net profit}$$

Revenue is the value of goods or services delivered (accrual basis, not cash). COGS is the direct cost to produce them.

Operating expenses (OPEX) cover running the business: rent, salaries, and marketing. EBIT isolates operational profit before financing and taxes.

Margins and Pitfalls

Net profit (the bottom line) is what remains after everything, flowing directly into retained earnings on the balance sheet.

Margins turn the waterfall into percentages of revenue:

$$\text{Gross margin} = \frac{\text{Gross profit}}{\text{Revenue}}$$ $$\text{Operating margin} = \frac{EBIT}{\text{Revenue}}$$ $$\text{Net margin} = \frac{\text{Net profit}}{\text{Revenue}}$$

Example: A firm with a 40% gross margin and 5% net margin keeps 40 cents per euro after production, but only 5 cents after all costs.

Common pitfall: Reading net profit as cash earned. Accrual revenue includes unpaid invoices, and expenses include non-cash depreciation. Profitable firms can still die of cash starvation.