Income Statement Structure & Key Components

The “Movie” Analogy (The P&L Engine - Accrual vs. Cash Basis)

Unlike the Balance Sheet snapshot, the Income Statement is a video showing performance over a specific window (Quarterly/10-Q or Annual / 10-K)

The Matching Principle (The P&L Engine - Accrual vs. Cash Basis)

Expenses must be recognised in the same period as the revenue they helped generate

Revenue recognition (The P&L Engine - Accrual vs. Cash Basis)

Revenue is recorded when “earned” and “realisable”, not necessary when cash hits the bank

Gross Revenue (The Top Line - Revenue and Gross Profit)

The total value of all sales transactions

Contra-Revenue (The Top Line - Revenue and Gross Profit)

Deductions for sales returns, allowances for damaged goods, and early payment discounts

Net Revenue (The Top Line - Revenue and Gross Profit)

The true starting point for analysis (Net Sales), calculated as Gross Revenue - Contra-revenue accounts

Cost of Goods Sold (COGS) (The Top Line - Revenue and Gross Profit)

Direct Materials: raw materials, Direct labour: factory / service staff, Manufacturing Overhead: utilises for the point

Gross Profit (The Top Line - Revenue and Gross Profit)

Net Revenue - COGS, represents the “core profitability” of the product itself

Selling, General & Administrative (Operating Expenses [OPEX] - The Cost of Running the Business)

Selling: Marketing, commissions, and advertising; General & Administrative: Executive salaries, rent, and legal fees.

Research and Development (R&D) (Operating Expenses [OPEX] - The Cost of Running the Business)

Costs associated with innovating new products, expensed immediately in the US

Depreciation & Amortisation (Operating Expenses [OPEX] - The Cost of Running the Business)

The non-cash allocation of the cost of physical and intangible assets

EBITDA meaning (Operating Expenses [OPEX] - The Cost of Running the Business)

Stands for “Earnings Before Interest, Taxes, Depreciation, and Amortisation”

EBITDA usage (Operating Expenses [OPEX] - The Cost of Running the Business)

Used as a proxy for “Operating Cash Flow”,, it allows for comparison between companies between companies with different capital structures (Debt) and assets asset ages (Depreciation).

EBIT (Operating Expenses [OPEX] - The Cost of Running the Business)

Stands for “Earnings Before Interest and Taxes”, it reflects the true Operating Profit after accounting for the wear and tear of assets

Interest Expense (“Below the Line” - Non Operating Items)

The cost of ‘servicing debt’ dependent on the company’s leverage

Interest Income (“Below the Line” - Non Operating Items)

Earnings from cash balances

Other Income / Expenses (“Below the Line” - Non Operating Items)

One-time gains like gains / losses on the sale of equipment or legal settlements

Pre-Tax Income (EBT) (“Below the Line” - Non Operating Items)

The amount of profit subject to the corporate tax rate

Income Tax Expense (The Bottom Line - Net Income and EPS)

Calculated based on the effective tax rate which often differs from the statutory rate

Net Income (The Bottom Line - Net Income and EPS)

The “residual” profit available for distribution as dividends or reinvestments as retained earnings

Earnings per Share (EPS) (The Bottom Line - Net Income and EPS)

Basic EPS: Net Income / Basic Shares Outstanding; Diluted EPS: Factors in “potential” shares (stock options, convertible), this is the number analysts watch most

Points Recap (Summary Waterfall - From Sales to Profit)

The P&L is a series of “subtraction” desined to isolate different types of efficiency

Cash vs. Accounting discrepancy

Reminder that high-Net Income does not always mean high Cash Flow (due to D&A and Accruals)