How to read an income statement

Key takeaways

• The income statement runs from revenue through gross profit, operating income, pretax income and net income to earnings per share.
• Depreciation and amortization are usually embedded in cost of goods sold and operating expenses, so EBITDA is built by adding D&A from the cash flow statement back to operating income.
• Net income attributable to the parent excludes the share of profit belonging to minority (non-controlling) shareholders of subsidiaries, and it is the numerator for EPS.
• Diluted EPS assumes in-the-money options are exercised and the proceeds buy back shares at the average price: the treasury stock method.
• Margins express each profit level as a share of revenue and are the first tool for comparing companies of different size.
• IFRS lets companies present expenses by nature or by function; IFRS 18 will require defined operating profit subtotals from 2027.

The shape of the statement

Most income statements follow the same order: revenue at the top, then the costs of producing that revenue, then the costs of running the business, then financing costs and taxes, and finally net income and earnings per share. Each subtotal strips out one more layer of cost, which is why analysts talk about moving down the P&L.

Companies present this in one of two formats. A single-step income statement lists all revenues and gains together, all expenses and losses together, and subtracts one from the other once. A multi-step income statement inserts intermediate subtotals, typically gross profit and operating income, to separate the core trading performance from financing and other items. Almost every large company uses the multi-step format, and it is the one an analyst needs.

Revenue, cost of goods sold and gross profit

Revenue, sometimes called net sales or turnover, is the value of goods and services delivered to customers in the period, net of returns, discounts and rebates. It is recognized under ASC 606 or IFRS 15 when performance obligations are satisfied. Some companies show gross revenue and deductions separately before arriving at net revenue.

Cost of goods sold (COGS), called cost of sales or cost of revenue in some filings, is the direct cost of the goods or services sold: materials, direct labor, manufacturing overhead and, for a service business, the cost of the people who deliver the service. For a manufacturer it includes depreciation of factory equipment, which is the first place D&A hides inside another line.

Gross profit is revenue less COGS. Gross margin, gross profit divided by revenue, measures how much of each sales dollar is left to pay for everything else. It reflects pricing power and production efficiency, and it varies enormously by industry: software companies and luxury brands keep most of each dollar, grocers and distributors keep a small fraction.

Operating expenses, D&A and operating income

Below gross profit sit the operating expenses. Selling, general and administrative expense (SG&A) covers sales teams, marketing, head office, finance, legal and similar overhead. Research and development (R&D) is shown separately by companies that spend heavily on it. Under US GAAP most research and development cost is expensed as incurred; under IFRS research is expensed but development cost is capitalized once specific criteria are met, which is one reason R&D-heavy companies can look different under the two frameworks.

Depreciation and amortization (D&A) is the allocation of the cost of tangible assets (depreciation) and identifiable intangible assets (amortization) over their useful lives. Some companies show D&A as its own line. Many do not: they embed it in COGS and SG&A according to which function uses the asset. You then find the total on the cash flow statement, where it is added back, or in the notes.

Operating income is gross profit less operating expenses. Analysts often call it EBIT, earnings before interest and taxes, though the two can differ if a company reports non-operating gains or losses above the interest line. EBITDA adds D&A back to EBIT. It is not defined by US GAAP or IFRS, so every company and every credit agreement can define it slightly differently, and adjusted EBITDA adds back further items management considers non-recurring.

From operating income to net income

Below operating income come the non-operating items. Interest expense is the cost of debt, including amortization of debt issuance costs. Interest income is earned on cash and investments. Many companies show them net as net finance cost. Other non-operating items include foreign exchange gains and losses, gains or losses on investments, and the share of profit from equity-method investees (companies in which the reporting company holds significant influence but not control).

Pretax income, also called income before taxes or earnings before tax (EBT), is operating income less net interest and other non-operating items. Income tax expense follows. It includes both current tax, payable to the authorities for this period, and deferred tax, which arises when accounting income and taxable income recognize items in different periods. The effective tax rate is tax expense divided by pretax income, and it often differs from the statutory rate because of foreign rates, credits and non-deductible items.

Net income is pretax income less tax. If the company has subsidiaries it does not wholly own, the statement then splits net income between the part attributable to the parent's shareholders and the part attributable to non-controlling interests, historically called minority interest. The consolidated statements include 100 percent of a controlled subsidiary's revenue and costs, so this split carves out the profit that belongs to the outside owners. Discontinued operations, if any, are shown separately, net of tax, just above net income.

Margins: comparing profit at every level

A margin divides a profit measure by revenue. Margins remove the effect of size, so a $2.4 billion company can be compared with a $200 million competitor, and they show where in the cost structure one company differs from another. Two businesses with the same net margin can reach it very differently: one with high gross margin and heavy marketing, the other with thin gross margin and lean overhead.

Each margin answers a different question. Gross margin speaks to pricing and production. EBITDA margin approximates operating cash generation before capital spending and is the margin most quoted in private equity and leveraged finance. EBIT margin reflects the full cost of operating including the wear on assets. Net margin captures the effect of leverage and tax.

Earnings per share: basic and diluted

Earnings per share (EPS) divides the profit available to common shareholders by the number of common shares. The numerator is net income attributable to the parent less any preferred dividends, because preferred shareholders rank ahead of common. The denominator is the weighted average number of shares outstanding during the period, not the count on the last day, because profit was earned across the whole period while the share count changed.

Basic EPS uses only shares actually outstanding. Diluted EPS asks what EPS would be if every instrument that could become common stock did so, provided the conversion would reduce EPS. Instruments that would increase EPS, called antidilutive, are excluded. Both US GAAP (ASC 260) and IFRS (IAS 33) require public companies to present both figures.

Options and warrants are handled with the treasury stock method. It assumes in-the-money options are exercised at the start of the period (or at issuance, if later) and that the cash the company receives on exercise is used to repurchase shares at the average market price for the period. Only the net new shares are added. Options with a strike price above the average price are out of the money, would be antidilutive, and are ignored.

Convertible bonds and convertible preferred stock use the if-converted method. It assumes conversion at the start of the period, adds the resulting shares to the denominator, and adds back to the numerator the after-tax interest (or preferred dividends) that would no longer be paid.

US GAAP and IFRS presentation differences

The two frameworks agree on what profit is far more than they disagree on how it is laid out. Differences in presentation still trip up cross-border comparisons, especially between US and European or Asian companies.

The largest is expense classification. IFRS (currently IAS 1) allows a company to classify expenses by function, such as cost of sales and administrative expenses, or by nature, such as raw materials, employee benefits and depreciation. A company using function must disclose nature information in the notes. US public companies present expenses by function under SEC rules, and a nature-based statement makes a clean gross margin impossible to compute.

Subtotals are the second. US filers typically show operating income. IAS 1 does not require an operating profit subtotal, so European companies define it inconsistently. IFRS 18, which replaces IAS 1 for annual periods beginning on or after 1 January 2027, introduces defined categories (operating, investing and financing) with required subtotals for operating profit and for profit before financing and income taxes, and requires disclosure of management-defined performance measures in the notes. In the US, ASU 2024-03 separately requires more disaggregation of expense captions in the notes.

Neither framework allows extraordinary items today: IFRS prohibits them, and US GAAP removed the category. Both require discontinued operations to be shown separately, net of tax.