From revenue at the top to net income at the bottom
The income statement reads top-to-bottom like a waterfall. At the top: total revenue. At the bottom: net income (also called net profit, or "earnings"). In between: a sequence of subtractions for various costs. Each line in the middle tells you which costs ate which slice of revenue.
The classic structure (simplified):
Revenue 1,000 − Cost of Goods Sold 600 = Gross Profit 400 − Operating Expenses 200 = Operating Income (EBIT) 200 − Interest Expense 30 = Pre-Tax Income (EBT) 170 − Taxes 40 = Net Income 130
Revenue is what came in. Each subtraction is what went out for one category of cost. What's left at each step has its own name. Net income at the bottom is what's left for shareholders (after everyone — suppliers, employees, lenders, government — got paid).
The four "earnings" lines you'll hear about
People say "earnings" loosely, but the income statement has at least four meaningful lines that get called earnings depending on context:
- Gross profit = Revenue − COGS. How much money comes off the product after direct costs.
- Operating income (EBIT) = Gross profit − OpEx. Earnings before interest and taxes — measures the core business's earning power, independent of how it's financed or taxed.
- Pre-tax income (EBT) = EBIT − interest. Earnings before tax.
- Net income = EBT − taxes. The bottom line.
News headlines mostly use "earnings" to mean net income (or earnings per share = net income / shares outstanding). Investment analysts sometimes prefer EBIT (independent of capital structure) or EBITDA (EBIT + Depreciation + Amortization, a rough cash-flow proxy). Knowing which "earnings" someone means matters.
Margins — what each percentage tells you
Each line of the income statement, divided by revenue, gives a margin:
- Gross margin = Gross profit / Revenue. How much of each revenue ₩ becomes gross profit. High = strong pricing power and/or low input costs.
- Operating margin = Operating income / Revenue. Adds in the cost of running the business.
- Net margin = Net income / Revenue. The final percent of revenue that becomes shareholder earnings.
Margins are pure ratios — numerator-denominator play (Track 1 lesson 3) again. Comparing margins across companies in the same industry tells you who's more efficient. Comparing one company's margins over time tells you whether they're improving or slipping.
Why this matters for valuation
Net income is the input to several valuation tools:
- P/E ratio uses earnings (Track 6 lesson 3)
- Earnings growth rate (g) in Gordon Growth often comes from analyst earnings projections
- Return on equity (ROE) = Net income / Shareholders' equity (next lesson on the balance sheet)
But for DCF, we ultimately want free cash flow, not earnings. Earnings include non-cash items (depreciation, amortization). Cash flow corrects for those. Lesson 5-6 closes that gap.
The takeaway
Income statement = waterfall from revenue to net income, with subtractions at each step. Four flavors of "earnings" (gross, EBIT, pre-tax, net) — knowing which one is being quoted matters. Margins = each line / revenue, useful for comparison. Net income drives EPS and P/E, but valuation eventually wants cash flow (FCF — lesson 5-6).