Reading an income statement: revenue, costs, EBIT and net income

What you will learn

• The structure of an income statement from revenue to net income
• What EBIT, EBITDA and earnings per share (EPS) mean and how to calculate them
• How to spot one-off items and "adjusted" figures
• Where to find the statements in an annual report

Explanation

The difference between revenue, profit and cash flow is covered in the Business course ("Revenue vs profit vs cash flow"). Here you apply it to a listed company's published accounts.

The income statement (also called profit and loss statement, P&L German: Gewinn- und Verlustrechnung) shows revenue and expenses over a period, usually a quarter or a year. Listed companies in the EU prepare consolidated accounts under International Financial Reporting Standards (IFRS); US companies use US Generally Accepted Accounting Principles (US GAAP). Line names differ slightly, but the logic is the same.

The main lines, top to bottom

1. Revenue (sales, turnover): money earned from selling goods and services in the period.
2. Cost of goods sold (COGS, cost of sales): direct costs of producing what was sold.
3. Gross profit = revenue − COGS.
4. Operating expenses: selling, general and administrative costs (SG&A), research and development (R&D), and depreciation and amortisation (D&A). Depreciation spreads the cost of physical assets such as machines over their useful life; amortisation does the same for intangible assets such as software or patents. Some companies include D&A inside COGS and SG&A rather than showing it separately.
5. EBIT (earnings before interest and taxes, often close to "operating profit") = gross profit − operating expenses. It shows what the core business earns before financing and tax.
6. Financial result: interest expense minus interest income.
7. EBT (earnings before taxes) = EBIT − net interest.
8. Income tax expense.
9. Net income (net profit) = EBT − tax. Part may belong to minority (non-controlling) shareholders of subsidiaries; the part "attributable to shareholders of the parent" is what belongs to you.

EBITDA (earnings before interest, taxes, depreciation and amortisation) = EBIT + D&A. It is popular because it is close to operating cash generation, but it ignores the real cost of replacing machines and software.

Earnings per share (EPS) = net income attributable to shareholders ÷ average number of shares outstanding. "Diluted EPS" also counts shares that could be created from stock options or convertible bonds.

One-offs and adjusted figures

Restructuring costs, asset sales, impairments (write-downs of asset values) or legal settlements can make one year look unusually good or bad. Companies often publish "adjusted EBIT" or "adjusted EPS" that remove such items. These numbers are not defined by IFRS. Always read the reconciliation to the reported figures and ask: do these "one-offs" appear every year?

Where to find it

Listed companies publish annual and half-year reports on the investor relations section of their own website. The statements come after the management report; the notes explain each line.

Worked example

Hypothetical example: Nordlicht AG, financial year, figures in € million. Assumptions: tax rate 30% of EBT, 50 million shares outstanding, no minority interests.

1. Gross profit: €500m − €300m = €200m.
2. EBIT: €200m − €90m − €30m − €20m = €60m.
3. EBITDA: €60m + €20m = €80m.
4. EBT: €60m − €10m = €50m; tax: 30% × €50m = €15m.
5. Net income: €50m − €15m = €35m.
6. EPS: €35m ÷ 50m shares = €0.70.

We will reuse Nordlicht AG in the next lessons.

Common mistake

Practice activity

Hypothetical: revenue €200m, COGS €120m, total operating expenses €50m (including €10m D&A), interest expense €5m, tax rate 25%, 25 million shares. Calculate gross profit, EBIT, EBITDA, net income and EPS.

Key takeaways

• Read the income statement from revenue down to net income attributable to shareholders.
• EBIT shows core operating profit; EBITDA adds back D&A but ignores reinvestment needs.
• EPS divides net income by the average share count; check diluted EPS.
• Treat "adjusted" figures with care and compare them with reported figures.

Next step

Next, you will read the balance sheet to see what the company owns and owes.