The Income Statement

The Story of a Period

The income statement (profit and loss statement, P&L) measures performance over time — a month, a quarter, a year — in contrast to the balance sheet's snapshot at a point in time.

Its structure is a waterfall:

$$\text{Revenue} - \text{COGS} = \text{Gross profit}$$ $$\text{Gross profit} - \text{Operating expenses} = \text{Operating profit (EBIT)}$$ $$EBIT - \text{Interest} - \text{Tax} = \text{Net profit}$$

Revenue (or sales, or turnover): the value of goods delivered or services rendered, measured at the price charged. Not cash received — accrual recognizes revenue when earned.

Cost of goods sold (COGS): the direct cost of producing what was sold — raw materials, direct labor, manufacturing overhead. Gross profit is the spread between what you charged and what it cost to make.

Operating expenses (OPEX): selling, general, and administrative costs — rent, salaries, marketing, depreciation. These are the cost of running the business, not making the product.

EBIT (earnings before interest and tax) is the profit from operations alone — before the cost of financing (interest) and the government's share (tax). It lets you compare operational performance across firms with different capital structures.

Net profit (the bottom line): what remains after everything. This flows into retained earnings on the balance sheet — the link between the two statements.

Margins turn the waterfall into percentages:

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

A firm with 40% gross margin and 5% net margin is saying: 40 cents of every revenue euro survives production, but only 5 cents survives everything else. The spread between gross and net is where management lives — or hides.

Each level, one question

Common pitfall: Reading net profit as cash earned. Accrual revenue includes uncollected invoices; expenses include non-cash depreciation. Profitable firms die of cash starvation — that is why the cash flow statement exists.