Reading the Income Statement

Where the balance sheet is a snapshot, the income statement (also called the profit and loss statement, or P&L) is a movie — it shows how much money a company made and spent over a period of time, typically a quarter or a year. It starts at the top with revenue (total sales) and works down through various costs to arrive at net profit at the bottom, which is why investors often talk about a company's "top line" and "bottom line".

Between revenue and net profit sit several important checkpoints. Gross profit is revenue minus the direct cost of producing goods or services sold — it tells you how efficiently the core business turns raw inputs into sales. Operating profit (or EBIT — earnings before interest and taxes) subtracts operating expenses like salaries, rent, and marketing, revealing how profitable the actual business operations are, independent of how the company is financed or taxed.

Net profit is what remains after interest on debt and taxes are also subtracted — the number that ultimately belongs to shareholders. A useful habit is tracking the gap between operating profit and net profit: a company with strong operating profit but weak net profit due to heavy interest payments is telling you something important about how much debt is weighing on the business.

Margins — profit expressed as a percentage of revenue rather than an absolute number — matter more than the absolute profit figures for comparing companies of different sizes. Gross margin, operating margin and net margin, tracked over several years, reveal whether a company's profitability is improving, stable, or eroding, which is often a more honest signal than a single year's headline profit number, which can be flattered or dragged down by one-off events.