Income Statement

Introduction to the Income Statement

At its most basic level, the Income Statement lists a firm's Revenue, operating and other expenses, and how much money was left over in some currency during a specific period of time.  This simplicity makes the Income Statement the most intuitive of the accounting tables in a financial report.

The Income Statement typically covers a three-month fiscal quarter or a fiscal year.  To facilitate comparisons, a quarterly Income Statement will show, side by side, data for the designated quarter and for the year-earlier period.  Annual Income Statements will list results for two or three consecutive years.

The bottom-line figure, which is called either Net Income or Net Earnings, is expressed both in absolute terms (dollars, or another currency) and in an amount related the number of common shares the company has outstanding (dollars per share).

Earnings Per Share gets the most attention in the financial press.

Assumptions made by corporate management can have a great effect on the Income Statement's figures.  Earnings, which might appear to be the result of mere arithmetic, are more subjective that it might appear.


The "top-line" of the Income Statement lists the company's Revenue, or Sales, during the quarter or year.  The notes accompanying the financial statements will indicate what rules the company followed to recognize a transaction as Revenue.  The rules will address questions such as: what if the company sells an item to wholesaler that can return the item if it is not bought by a consumer?  What if the company receives funds for a service or product it will deliver in the future.

Determining Revenue is more complicated than counting the cash in the till each day.

Operating Costs or Expenses and Operating Income

The next section of the Income Statement lists the expenses that can be tied, directly or indirectly, to the creation and sales of the company's products.

The Cost of Goods Sold (CGS) (a/k/a Cost of Revenues) includes the labor and material costs to create the company's products.  It is usually the largest Operating Expense.

Depreciation of the equipment and facilities used for company operations might be included in CGS, or it might be broken out separately.  This non-cash expense reflects decreasing value over time of the company's capital equipment.

Other typical operating expense categories are Research and Development (R&D); Sales (i.e., marketing), General and Administrative (SG&A); and non-recurring Special Operating Charges (less frequently Gains).  The markdown (or write-down) of the value of  Inventory is an example of a special charge.  This is one example of an Asset being recognized as impaired.

Operating Income is found by subtracting Operating Costs/Expenses from Revenue.

Non-Operating Income and Expense

Non-operating items might include categories such as Gains or Losses on Investments, Gains or Losses on Asset Sales, Net Interest Income or Expense, and the catchall miscellaneous category.

The company's Pre-tax Income, or Taxable Income, is determined by adding the Non-operating gains to, and subtracting the Non-operating losses from, Operating Income.

A provision for Income Taxes reduces Income to the bottom-line figure.

Net Income

Net Income is divided by the number of Common Shares Outstanding to compute the widely reported Earnings per Share (EPS). Sometimes non-recurring gains and losses are excluded from the EPS values one sees in the newspaper or on TV, so the analyst has to treat these values with extreme caution. 

Income Statement Example

While most Income Statements have the same general structure, they can differ substantially in the details.  The following is a fictitious example, which we use below to illustrate what can be learned from the Income Statement.

(Millions of $)

Quarter ending
30 June 2006
Quarter ending
30 June 2005
Year ending
30 June 2006
Year ending
30 June 2005
Op expenses

CGS (39.1)(33.0)(149.1)(127.1)



SG&A (3.2)(1.7)(11.1)(7.1)

Other ("Special")(0.1)(0.2)(0.4)(0.8)
Operating Income
Other income

Gains on asset sales0.

Gains on investments2.

Net Interest and other income(1.2) (1.0)(4.1)(4.8)
Pretax income
Provisions for Income taxes
(2.9) (2.6)(12.1)(11.9)
Net Income before adjustments

Equity income less minority interests0.

Discontinued operations and Accounting changes0.
Net Income
Earnings per Share ($/sh)
Shares outstanding (M)

What Can be Learned from the Income Statement?

The Income Statement can reveal a lot about an organization's operations.  To gain those insights, financial analysts measure the rate of change for key Income Statement items, and they calculate various ratios using data from the Income Statement, other financial statements, and the supporting Notes

The importance of any particular ratio depends on the size, type, and condition of the company being evaluated.  Changes in the ratios over time are often more revealing than the values themselves.  It can also be useful to compare ratios for one company with other firms in the same industry. 

GCFR uses the ratios described below.

Revenue Growth

Changes in the company's Revenue can be characterized in various ways.  To eliminate seasonal factors, it is common to compare Revenue in one quarter to Revenue in the same quarter of the previous year.

Less widely used, sequential quarterly Revenue growth compares Revenue in the current quarter to Revenue in the immediately preceding quarter.

To smooth out the trend, we compare Revenue during the previous four quarters to Revenue during the prior four quarters.  We refer to this growth rate as "year-over-year" growth or "trailing 4-quarters."  Readers should be aware that there are alternative definitions for these terms.  The year in these calculations will coincide with the fiscal year only 25 percent of the time.

(Millions of $)
Revenue Growth
Quarters ending June 2006 and June 2005(52.2 - 43.9)/43.9 = 18.9%
Years ending June 2006 and June 2005(198.1 - 170.0)/170.0 = 16.5%

Operating Expenses/Revenue

The ratio of each Operating Expense item to Revenue shows what the company spent to realize each sales dollar.  We make these calculations for the current quarter and for the last four quarters.  If the company is able to achieve efficiencies of scale as it increases Revenue, costs as a percentage of Revenue will drop, and more of each sales dollar will reach the bottom line as earnings.

We subtract CGS/Revenue from 1 to determine the Gross Margin.   Alternatively, this can be expressed as (Revenue- CGS)/Revenue.  A high Gross Margin is preferred, as it indicates that the company can sell its goods and services for much more than the production cost.  We find it more useful to compare the Gross Margins from year to year, rather than from quarter to quarter because the data for shorter periods can be volatile.

For fictional GCFR Inc., using figures from the sample Income Statement above:

(Millions of $)
Gross Margin
Quarter ending June 20061 - (39.1/52.2) = 25.1%
Quarter ending June 20051 - (33.0/43.9) =  24.8%
Year ending June 20061 - (149.1/198.1) = 24.7%
Year ending June 20051 - (127.1/170.0) = 25.2%

When the data is available, we separately calculate Depreciation/Revenue, R&D/Revenue, and SG&A/Revenue.  Depreciation is included in CGS for some firms, and some firms don't engage in R&D.

As was mentioned for Gross Margin, we prefer to compare the expense ratios from year to year, rather than from quarter to quarter.  Seemingly random variations in shorter periods can obscure the underlying trends and lead to erroneous conclusions.

(Millions of $)
Quarter ending June 20061.0/52.2 = 1.9%2.1/52.2 = 4.0%3.2/52.2 = 6.1%
Quarter ending June 20051.3/43.9 = 3.0%1.8/43.9 = 4.1%1.7/43.9 = 3.9%
Year ending June 20064.0/198.1 = 2.0%8.2/198.1 = 4.1%11.1/198.1 = 5.6%
Year ending June 20053.9/170.0 = 2.3%6.0/170.0 = 3.5%7.1/170.0 = 4.2%

Finally, the ratio of total Operating Expense to Revenue gives an indication of the company's overall profitability.

(Millions of $)
Operating Expense / Revenue
Quarter ending June 2006(39.1 + 1.0 + 2.1 + 3.2 + 0.1) / 52.2  = 87.2%
Quarter ending June 2005(33.0 + 1.3 + 1.8 + 1.7 + 0.2) /43.9 = 86.6 %
Year ending June 2006(149.1 + 4.0 + 8.2 +11.1 + 0.4) / 198.1 = 87.2%
Year ending June 2005(127.1 + 3.9 + 6.0 + 7.1 + 0.8) / 170.0 = 85.2%

Operating Income and Net Income Growth

Quarter-over-quarter and year-over-year Income growth rates can be calculated in the same way as Revenue.

(Millions of $)
Operating Income GrowthNet Income Growth
Quarters ending June 2006 and June 2005(6.8 - 6.1) / 6.1 = 11.5%(5.5 - 4.8) / 4.8 = 14.6%
Years ending June 2006 and June 2005(25.3 - 25.1) / 25.1 = 0.8%(20.1 - 17.3) / 17.3 = 16.2%

Income Tax Rate

The ratio of Provisions for Income Taxes to the Income before Taxes should be checked to see if the tax rate has changed.  We've seen companies trumpet increased earnings that were due primarily to a change in the tax rate (and had nothing to do with the fundamental functioning of the business).  Because the quarterly data can be quite volatile, the annual tax rate is better suited for earnings models.

(Millions of $)
Income Tax Rate
Quarter ending June 20062.9/8.4 = 34.5%
Quarter ending June 20052.6/7.4 = 35.1%
Year ending June 200612.1/32.2 = 37.6%
Year ending June 200511.9/29.2 = 40.8%


The ratio of Revenue during a quarter or year to Total Assets indicates how effectively and efficiently the company is employing its Assets to generate sales. The key is to look for changes: is the efficiency increasing or decreasing?

Total Assets is a figure listed on the Balance Sheet.  When making the Revenue/Assets calculation, the amount of Assets at the end of the period can be used.  However, a more representative calculation can be made by averaging the Asset values at the beginning and end of the period.  The difference between these two approaches is more significant for small, rapidly growing companies.

Note that Revenue/Assets for a quarter will be about 25 percent of Revenue/Assets for the year.  We multiply the quarterly result by 4 to make it more comparable with annual data.  However, this approach can produce misleading results if sales are highly seasonal.  In this case, an analyst would want to look at historical trends to determine the typical distribution of Revenue over the year.

Let's assume a series of Balance Sheets for fictional GCFR Inc. listed the following values for Total Assets:

DateTotal Assets ($M)

We compute Revenue/Assets as shown below:

(Millions of $)
Quarter ending June 20064*52.2/[0.5*(255.0+234.0)] = 85.4%
Quarter ending June 20054*43.9/[0.5*(202.5+197.4)] = 87.8%
Year ending June 2006198.1/[0.5*(255.0 +202.5)] = 86.6%

Operating Profit or Net Operating Profit after Taxes

Operating Profit is a variation of the Operating Income item on the Income Statement.  We calculate it by excluding unusual operating gains and losses from Operating Income and adjusting the remainder to reflect Income Taxes. 

     Operating Profit (a/k/a NOPAT) = (Operating Income + Special Charges) * (1 - Income Tax Rate)

Operating Profit differs from Net Income in that it excludes Non-Operating income and expenses, such as interest and investment returns.

At GCFR, we calculate and track Operating Profit's average annual growth rate over the last 16 quarters.  This growth rate should be less volatile than the Net Income growth rate because special items are excluded and the longer averaging time (16 vs. 4 quarters).

Net Operating Profit after Taxes/Revenue

NOPAT/Revenue is a good measure of the profitability of the company's core business.
It would be rare for us to compute this ratio with quarterly values, but we include quarter and annual NOPAT/Revenue values in the table below to show how the calculation would be made.

(Millions of $)
Quarter ending June 2006(6.7 + 0.1) * (1 - 0.345) / 52.2 = 8.5%
Quarter ending June 2005(5.9 + 0.2) * (1 - 0.351) / 43.9 = 9.0%
Year ending June 2006(25.3 + 0.4) * (1 - 0.376) / 198.1 = 8.1%
Year ending June 2005(25.1 + 0.8) * (1 - 0.408) / 170.0 = 9.0%

Net Income/Revenue

Net Income as a percentage of Revenues (a/k/a Net Margin) is a more complete measure of profitability, but it can be swayed by extraordinary non-operational changes.

(Millions of $)
Net Income/Revenue
Quarter ending June 20065.5/52.2 = 10.5%
Quarter ending June 20054.8/43.9 = 10.9%
Year ending June 200620.1/198.1 = 10.1%
Year ending June 200517.3/170.0 = 10.2%

Net income/Stockholders' Equity

This a basic return-on-investment ratio.  Stockholders have a right to expect that the company will make more for each dollar of investment than lower risk securities.

Stockholders' (or Shareholders') Equity is listed on the Balance Sheet.  When making the Net Income/Equity calculation, the Equity at the end of the period can be used.  However, a more representative calculation can be made by averaging the Equity values at the beginning and end of the period.  The difference between these two approaches is more significant for small, rapidly growing companies.

Note that Net Income/Equity for a quarter will be about 25 percent of Net Income/Equity for the year.  We multiply the quarterly result by 4 to make it more comparable with annual data.  However, this approach can produce misleading results if Net Income is highly seasonal.  In this case, an analyst would want to look at historical trends to determine the typical distribution of Net Income over the year.

Let's assume a series of Balance Sheets for fictional GCFR Inc. listed the following values for Stockholders Equity:

DateStockholders Equity ($M)

We compute Net Income/Equity as shown below:

(Millions of $)
Net Income/Equity
Quarter ending June 20064*5.5/[0.5*(134.0+120.5)] = 17.3%
Quarter ending June 20054*4.8/[0.5*(101.7+99.2)] = 19.1%
Year ending June 200620.1/[0.5*(134.0+101.7)] = 17.1%

Return on Invested Capital (ROIC)

ROIC is a more subtle return-on-investment ratio that provides insight into how much the company earns on each dollar of capital provided by shareholders and lenders.  We use NOPAT for the last four quarters as the numerator, and Invested Capital, which we discussed in the Balance Sheet tutorial, as the denominator. 

From the NOPAT/Revenue discussion above, we can determine that the fictional GCFR Inc. had a 4-quarter NOPAT of (25.3 + 0.4) * (1 - 0.376) = $16.0 million as of 30 June 2006.

Invested Capital measures the investment, whether raised by stock sales or taking on debt, that is actually deployed (i.e., not sitting in the bank).  The definition for this term that we use is Stockholders' Equity, plus Short- and Long-Term Debt, minus Cash as the denominator.  These values are listed on the Balance Sheet.

(Millions of $)
30 June 2006
Short-term Investments11
Notes payable9
Long-term Debt60
Stockholders' Equity134

ROIC = 16 / (134 + 60 + 9 - 10 - 11) = 8.8%

Note: This post was originally published on 25 October 2006.  It was revised on 1 September 2008, 17 January 2009, 19 April 2009, 10 July 2010, and 4 August 2010.