An income statement lists, in order from top to bottom: revenue (or gross sales), minus returns and allowances to reach net sales; cost of goods sold; gross profit; operating expenses such as selling, general, and administrative costs and depreciation; operating income; non-operating income and expenses like interest and one-time gains or losses; pre-tax income; income tax expense; and net income. Public companies add earnings per share at the bottom. That sequence is what goes on an income statement, and each line answers a different question about how the business performed during the period.
Revenue and Net Sales
Revenue sits at the top, which is why people call it the “top line.” It captures the total dollars a business earned from its core activities during the reporting period, whether that means selling products, billing clients, or collecting subscription fees. The first figure shown is gross revenue: the raw total of every invoice before any adjustments.
Gross revenue rarely tells the full story. Customers return defective products, negotiate allowances for damaged shipments, or take early-payment discounts. Those come off gross revenue to produce net sales, the realistic starting point for everything that follows. A company that invoiced $5 million but processed $200,000 in returns and $50,000 in discounts reports $4.75 million in net sales. IRS Form 1120 mirrors this on its very first lines, requiring corporations to report gross receipts and then subtract returns and allowances.1Internal Revenue Service. U.S. Corporation Income Tax Return
One subtlety matters here: cash received before the work is done is not revenue yet. Under current accounting standards, revenue is recognized only when the company has actually delivered the goods or performed the service. A software company that collects $120,000 upfront for a one-year contract records $10,000 per month as revenue and carries the rest as deferred revenue, a liability that shrinks as performance catches up with the cash.
Cost of Goods Sold
Directly below net sales comes cost of goods sold (COGS): the expenses tied directly to producing what the company sold. A furniture manufacturer includes lumber, upholstery fabric, and the wages of workers who build the chairs. A consulting firm includes the salaries of consultants who billed time to clients. What you won’t find on this line is the CEO’s salary or the electric bill for corporate headquarters, because those costs don’t touch the product.
Inventory valuation changes this number. Two common methods are first-in, first-out (FIFO), which assumes the oldest inventory sells first, and last-in, first-out (LIFO), which assumes the newest moves first. When prices are rising, LIFO produces a higher COGS and lower reported profit; FIFO does the opposite. Switching to LIFO requires filing Form 970 with the IRS as part of that year’s tax return.2Internal Revenue Service. About Form 970, Application to Use LIFO Inventory Method
Gross Profit
Subtracting COGS from net sales produces gross profit, the first real profitability checkpoint on the statement. A high gross profit margin means the company has strong pricing power, a lean production operation, or both. A thin margin means the business is spending nearly as much to make its product as it earns selling it, leaving little room for everything that follows.
Gross profit is most useful when comparing companies in the same industry. A grocery chain and a software company have wildly different gross margins because their cost structures share almost nothing. Comparing two grocery chains, on the other hand, reveals which one sources inventory more efficiently or commands better shelf prices.
Operating Expenses
Below gross profit come the ongoing costs of running the business that aren’t tied directly to production. These are typically grouped under “selling, general, and administrative expenses” (SG&A) and include office rent, utilities, insurance, executive salaries, marketing campaigns, and human resources staff. The common thread: these costs keep the lights on, but they don’t vary much with how many units roll off the line.
Depreciation also appears in this section. When a company buys a long-lived asset like a delivery truck or a piece of factory equipment, it doesn’t expense the full cost in the year of purchase. It spreads the cost over the asset’s useful life. To qualify for depreciation, property must be used in the business, have a determinable useful life, and be expected to last more than one year.3Internal Revenue Service. Publication 946 (2025), How To Depreciate Property The annual depreciation charge reduces reported profit even though no cash leaves the building that year, which is one reason net income and actual cash flow often diverge.
A note worth keeping in mind: not every expense on the income statement produces a corresponding tax deduction. Starting in 2026, employer-provided meals are no longer deductible at all, though the expense still hits the income statement. Qualified transportation benefits for employees have been non-deductible since 2018.4Internal Revenue Service. Employer’s Tax Guide to Fringe Benefits The income statement reflects what the business actually spent; the tax return reflects what the IRS lets you deduct.
Operating Income
Subtracting total operating expenses from gross profit produces operating income, also called operating profit or EBIT (earnings before interest and taxes). This figure shows whether the company’s day-to-day business model is profitable on its own, before financial structure and tax strategy enter the picture. For an analyst trying to compare two businesses with different debt loads or tax situations, operating income is often the cleanest comparison point.
Non-Operating Income and Expenses
Below operating income, the statement captures financial activity that falls outside the core business. Interest expense on corporate debt is the most common item. A manufacturer that borrowed $2 million at 6% reports the $120,000 annual interest here, not in operating expenses, because it reflects a financing decision rather than a production decision. Interest earned on cash reserves or short-term investments shows up here too, as non-operating income.
One-time events land in this section. Selling a warehouse the company no longer needs, settling a lawsuit, or writing down the value of an investment all generate gains or losses that don’t reflect normal operations. Keeping them separate from operating income protects the usefulness of that operating figure. An investor who sees a sudden spike in total profit can check this section to see whether the jump came from better operations or from a real estate sale that won’t repeat.
Companies that have shut down or sold off an entire business segment must present those results as discontinued operations on a separate line after continuing operations, so the performance of a division that no longer exists doesn’t distort the picture of what’s still running.
Pre-Tax Income and Income Taxes
After non-operating items are added or subtracted, the result is pre-tax income, also called earnings before taxes. The income tax line then reduces that figure by the company’s total tax obligation for the period.
For C corporations, the federal rate is a flat 21% of taxable income.5Office of the Law Revision Counsel. 26 USC 11 – Tax Imposed That rate has been in place since the Tax Cuts and Jobs Act took effect in 2018 and applies regardless of how much the corporation earns. Most states also levy their own corporate income tax, with rates running from about 1% to 11.5% in the 44 states that impose one. Six states have none. The combined federal-plus-state burden is what actually shows up on the tax line.
The tax expense reported on the income statement often differs from the cash the company actually sends to the IRS that year. Timing differences between accounting rules and tax rules create deferred tax assets and liabilities. A company might depreciate an asset faster for tax purposes than it does on its financial statements, generating a short-term tax benefit that reverses later. The income statement captures the total tax cost attributable to the period, not just the check written to the government.
Net Income
Subtracting income taxes from pre-tax income produces net income, the bottom line. One number answers the fundamental question: did the company make money or lose it? A positive figure means total revenues exceeded total costs. A negative figure, called a net loss, means costs won.
Net income flows into several places. Retained earnings on the balance sheet grow by the amount of net income not paid out as dividends. For publicly traded companies, net income is the starting point for earnings per share. And for tax purposes, the income statement’s structure maps almost line-for-line onto IRS Form 1120, which requires corporations to report gross receipts, cost of goods sold, gross profit, a detailed list of deductions, and taxable income.1Internal Revenue Service. U.S. Corporation Income Tax Return
Earnings Per Share
Public companies are required to report earnings per share (EPS) on the face of the income statement for every period presented. Basic EPS divides net income available to common shareholders by the weighted-average number of common shares outstanding during the period. A company that earned $10 million in net income, paid $1 million in preferred dividends, and had 9 million weighted-average shares outstanding reports basic EPS of $1.00.
Diluted EPS takes the calculation one step further by asking what EPS would look like if every outstanding stock option, convertible bond, and warrant were exercised or converted into common shares. This usually produces a lower number, and the gap between basic and diluted EPS tells investors how much potential dilution exists. A small gap signals a clean capital structure with few lurking claims on future earnings. Private companies and sole proprietors don’t report EPS at all, so this line is specific to public issuers.
Single-Step vs. Multi-Step Formats
The ordered list above describes the multi-step income statement, which is what most publicly traded companies use. It breaks results into distinct tiers (gross profit, operating income, pre-tax income, net income), and each tier isolates a different dimension of performance.
A single-step income statement lumps all revenues together, lumps all expenses together, and subtracts one from the other to get net income in one calculation. Smaller businesses and sole proprietors often prefer this format because it’s simpler to prepare and read. The tradeoff: you lose the ability to separate operating performance from financing costs and one-time events. If all you need to know is whether the business made money, single-step works. If you need to diagnose why it did or didn’t, multi-step is the better tool, and that’s why the SEC-filed statements of large companies all follow the longer format.