How to Read an Income Statement from Revenue to Net Income
Follow revenue, cost of sales, SG&A, finance income and costs, and income tax through the income statement. Use amounts and margins to understand why net income can fall despite revenue growth.
An income statement shows which costs are deducted from revenue to arrive at final profit. Looking at both changes in amounts and changes as a percentage of revenue helps distinguish growth from selling more from improvements in the cost structure. Comparing only revenue and net income can obscure what happened between them.
Work down the statement, matching revenue with costs
For manufacturers and retailers that present cost of sales separately, first check gross profit, calculated as revenue less cost of sales. Next, examine operating profit after operating expenses such as selling, general and administrative expenses, followed by profit before and after income tax after finance income and costs, other gains and losses, and other items. Line names and placement vary by industry and presentation. Avoid directly comparing a bank's operating revenue with a manufacturer's product sales, or recording a company's separately presented adjusted profit as though it were the operating profit reported in its financial statements.
Separate the effects of scale and profitability
If both revenue and operating profit increase, calculate the operating margin as well. Profit may have risen in absolute terms while the margin fell. The implications for the next period depend on whether volume grew because of price cuts, raw material prices rose, or costs for a new business were incurred ahead of revenue. Reclassifying expenses between cost of sales and SG&A can also change particular margins, so check comparative statements and the notes explaining classification changes.
Find the line items that send net income in a different direction
If operating profit rises but net income falls, break down the difference into finance costs, disposal gains and losses, taxes, and other items. A gain on an asset sale that is unlikely to recur and a recurring interest burden should not be assessed as equivalent drivers of improvement. The effective tax rate can also fluctuate sharply when pretax profit is small. Rather than mechanically applying one historical year's tax rate to the next, read the explanations in the income tax note's reconciliation. Separately check the attribution of profit shown below net income for the period.
Worked example
Hypothetical example: All amounts below are in units of KRW 100 million. With revenue of 1,000, cost of sales of 650, and SG&A of 200, gross profit is 350 and operating profit is 150, giving margins of 35% and 15%, respectively. After net finance costs of 30 and other income of 10, pretax profit is 130. Income tax expense of 26 leaves net income of 104, or 10.4% of revenue. Writing the difference at each stage alongside the calculation shows why a 15% operating margin does not mean that 15% of revenue ultimately accrues to shareholders.
What to check
- Check whether the income statement covers three months or a cumulative period.
- Calculate gross margin, operating margin, and net margin separately.
- Identify the largest change between operating profit and net income.
- Check the portion of net income attributable to owners of the parent.
Sources and primary materials
This is educational material about research methods. For an actual company decision, verify the filings and primary sources for the relevant period.