Course → Unit 6: Reading Financial Statements → Lesson 6.1

The Income Statement (P&L)

Before you invest a single dollar in a company, you should be able to answer one basic question — does this business actually make money? — and the income statement is the document that answers it.

The waterfall: revenue to net profit

The income statement (also called the profit and loss statement, or P&L) shows how much a company earned and spent over a period — usually a quarter or a year — and what was left over at the end. It reads like a waterfall: you start at the top with everything the company brought in, and a series of costs get subtracted, layer by layer, until you reach what actually remains for shareholders.

Revenue (also called sales or turnover) is the total amount of money the company brought in from selling its products or services — the very top line, before any costs are subtracted. Gross profit is what's left after subtracting the direct cost of producing what was sold — for a coffee chain, that's the beans, milk, cups, and barista wages tied directly to making the drinks. Operating profit subtracts the broader running costs of the business — head office salaries, marketing, research and development, rent — the costs of running the company that aren't tied directly to a single unit sold. Net profit (the "bottom line") is what's left after everything else — interest paid on debt, taxes, and any one-off items — and it's the number that ultimately belongs to shareholders, whether paid out as dividends or reinvested in the business.

Gross margin and operating margin: what they reveal

Raw profit numbers are hard to compare between companies of different sizes, so investors convert them into percentages of revenue, called margins.

A high gross margin suggests a company doesn't spend much, relative to its sales, on the direct costs of making its product — often a sign of pricing power or an efficient, differentiated product (software companies often post gross margins above 70%, since delivering one more copy of a digital product costs almost nothing). A high operating margin suggests the business is well-run more broadly, not just efficient at production but disciplined about its overhead spending too. Comparing margins over time, or against close competitors in the same industry, is one of the fastest ways to judge whether a business is becoming more efficient, or losing ground.

EBITDA: useful, but easy to misuse

EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortisation — essentially, operating profit with two non-cash accounting charges (depreciation and amortisation, which spread the cost of long-lived assets like equipment or acquired intangible assets over many years) added back in. It's popular because it strips out financing decisions (interest), tax jurisdictions, and accounting choices about how quickly assets are written down, making it easier to compare the core, underlying profitability of companies with very different capital structures or tax situations.

The catch: EBITDA can flatter a company that has genuinely heavy, unavoidable capital spending needs — an airline or a telecom company has to keep replacing planes or network equipment, and depreciation reflects a real, ongoing cost of doing business, even though it isn't a cash outflow in the period it's recorded. A company can post a healthy EBITDA while its net profit (and cash flow, which you'll study in Lesson 6.3) look far weaker, once those real costs are counted. Treat EBITDA as one useful data point for comparison, never as a substitute for looking at net profit and cash flow too.

Worked example: a simplified P&L

Below is an illustrative, simplified income statement styled on the kind of numbers a large coffee retail chain might report in a single year (figures are illustrative, not the real company's actual results):

Reading this waterfall tells a story: the company keeps about 59 cents of gross profit on every dollar of sales, but by the time overhead, interest, and tax are paid, only about 10 cents of every dollar reaches the bottom line as net profit. That gap between gross margin and net margin is where the real cost of running a large, complex business shows up.