Financial statements
Reading an income statement
How an income statement works line by line: revenue − cost of revenue = gross profit, gross profit − operating expenses (R&D, SG&A) = operating income, down to net income and EPS — plus the margins each line produces.
What the income statement measures
The income statement (also called the profit-and-loss statement) reports performance over a period of time — a quarter or a fiscal year — rather than a single moment. It starts with revenue at the top and subtracts costs in stages until it arrives at net income at the bottom. This is why people call revenue the "top line" and net income the "bottom line".
Because it is a flow over a period, every figure answers "how much during these three or twelve months", not "how much is held right now". That point-in-time view belongs to the balance sheet, covered in the companion guide on reading a balance sheet.
Revenue, cost of revenue, and gross profit
Revenue is the total value of goods and services sold during the period. Cost of revenue (also called cost of goods sold, or COGS) is the direct cost of producing what was sold. The first identity is: revenue − cost of revenue = gross profit.
Gross profit is what is left to cover everything else — research, sales, administration, interest, and taxes. Dividing gross profit by revenue gives the gross margin, the share of each sales dollar that survives direct production costs.
Operating expenses and operating income
Below gross profit sit the operating expenses: research and development (R&D) and selling, general and administrative (SG&A). The next identity is: gross profit − operating expenses = operating income (also called operating profit or EBIT).
Operating income isolates the profit from running the core business, before financing costs and taxes. Operating margin is operating income divided by revenue. The profit-margins guide walks through how gross, operating, and net margins relate.
From operating income to net income and EPS
After operating income, the statement subtracts interest expense and income taxes (and adds or subtracts other items) to reach net income — the profit attributable to shareholders for the period.
Earnings per share (EPS) divides net income by the share count. Diluted EPS uses a share count that includes stock options and other potential shares, so it reflects possible dilution. The dilution-and-share-count guide explains why diluted EPS is usually the figure to watch.
Why earnings are not the same as cash
Net income is an accrual figure: it records revenue when earned and costs when incurred, regardless of when cash actually moves. Non-cash charges such as depreciation and amortization reduce net income without any cash leaving in the period.
That is why the income statement is read alongside the cash flow statement. The cash-flow-vs-earnings guide covers the gap between reported profit and cash generated, and the how-the-three-statements-connect guide shows how net income links to both the balance sheet and the cash flow statement.
Common questions
What is the formula for gross profit?
Gross profit = revenue − cost of revenue (cost of goods sold). Dividing gross profit by revenue gives the gross margin, the percentage of each sales dollar left after direct production costs.
What is the difference between operating income and net income?
Operating income is profit from the core business before interest and taxes (gross profit − operating expenses). Net income is the final figure after subtracting interest expense and income taxes, and is the profit attributable to shareholders.
Why is diluted EPS lower than basic EPS?
Diluted EPS divides net income by a larger share count that includes stock options and other potential shares. Because the denominator is larger, diluted EPS is usually lower than basic EPS and better reflects possible dilution.