Skip to content
Accounting · 6 min read

How to read an income statement

What each line of an income statement tells you, what it never tells you, and why profit does not mean there is cash.

The short answer

An income statement measures a period’s performance: it starts with revenue, subtracts the cost of what you sold to reach gross profit, then subtracts operating expenses to reach net profit. Reading it properly is not looking at the bottom line but at the ratios between the lines and how they compare with last period — and the bottom line tells you nothing about your bank balance.

The steps

  1. Revenue: what you sold, not what you collected

    Revenue is recorded when goods are delivered or a service is performed, not when the money arrives. That is why a month can show high revenue and a low bank balance: the difference is sitting in receivables. This is not a flaw in the statement — it is what makes it measure performance rather than the timing of collection.

  2. Cost of sales and gross profit

    Cost of sales is the cost of what actually left stock, not what you bought during the month. The gap between it and revenue is gross profit, and its ratio to revenue is the single most important number on the statement for a business that sells goods: if it drops suddenly, either a selling price fell, a buying cost rose, or stock is leaking — and all three are worth chasing today rather than at year end.

  3. Operating expenses: what you pay to stay open

    Rent, wages, electricity, marketing — you pay them whether you sold anything or not. That is why they are read as a share of revenue rather than as an amount: fixed costs of 80,000 are comfortable against revenue of 500,000 and suffocating against 120,000, and the figure is the same in both.

  4. Net profit, and what it does not say

    Net profit is not the cash that came in. Four things sit between them: invoices not yet collected, purchases that went into stock and have not sold, loan repayments that are not an expense, and depreciation which is an expense with no cash leaving. A profitable business fails when all of its profit is locked in the first two.

  5. Compare against a period, not an impression

    A single figure means nothing. Read the month against the same month last year if your trade is seasonal, or against last month if it is not. And look at the ratios: gross profit to revenue, expenses to revenue. A change in the ratio is the news; a change in the amount is not.

Common questions

What is the difference between an income statement and a balance sheet?
An income statement covers a period — a month, a year — and says what happened in it. A balance sheet is a single moment, and says what you own and owe on that day. The first is a film; the second is a photograph.
Why does my profit differ from my bank balance?
Because they measure different things. Profit measures performance on the accrual basis; the bank measures cash. Uncollected invoices, unsold stock, loan repayments and depreciation all sit between them.

Terms used in this guide

More guides

All guides