From revenue to profit: the waterfall
An income statement works like a funnel. Start with revenue (all money the company brought in). Then subtract each layer of costs. What's left after each subtraction gives you a different measure of profitability — each one revealing something different about the business.
A real income statement, simplified
| Line item | £ million | % of revenue |
|---|---|---|
| Revenue | 1,000 | 100% |
| Cost of goods sold (COGS) | (400) | 40% |
| Gross profit | 600 | 60% |
| Operating expenses | (250) | 25% |
| EBIT (operating profit) | 350 | 35% |
| Interest expense | (50) | 5% |
| Tax | (60) | 6% |
| Net profit | 240 | 24% |
Why different profit lines matter
Gross margin (gross profit ÷ revenue) reveals how efficiently the company produces its goods. A software company might have 70%+ gross margins; a supermarket might have 25%. Operating margin (EBIT ÷ revenue) shows the underlying profitability of the business before financial structure. Net margin is the bottom line — but can be distorted by unusual tax situations or one-time gains.
"Revenue is vanity, profit is sanity, cash is reality." — an old but useful finance saying
Income statement vs cash flow
Profit on the income statement doesn't equal cash in the bank. Revenue is recognised when earned, not when cash is collected. A company can be wildly profitable on paper but running out of cash if customers aren't paying. This is why the cash flow statement — especially operating cash flow — is often more revealing than net profit.
What this means for you
When evaluating any company, look at three trends in the income statement: is revenue growing? Are margins stable or improving? Is earnings-per-share rising faster than revenue (showing operational leverage)? A company with growing revenue but shrinking margins is being competed away. One with flat revenue but rising margins is becoming more efficient. Both stories are visible in the income statement.