Quick Answer
The income statement walks from revenue down to net income, subtracting COGS, operating expenses, interest, and taxes along the way. EBITDA, EBIT, and EBT are checkpoints along that walk, and basic and fully diluted EPS turn net income into a per-share profitability figure.
With the balance sheet providing a snapshot of financial position, the income statement tells you how the company actually performed over a period: whether it made or lost money.
What Is the Income Statement Structure?
The income statement follows a top-down flow from revenue to net income. Each line subtracts a category of expenses:
Revenue (Sales)
- Cost of Goods Sold (COGS)
= Gross Profit
- Operating Expenses (Selling, General & Administrative, depreciation)
= Operating Income (EBIT)
- Interest Expense
= Earnings Before Taxes (EBT)
- Income Taxes
= Net Income (Net Profit)
- Revenue (the "top line"): total sales before any deductions
- Net income (the "bottom line"): what remains after all expenses
Exam Tip: Gotchas
- "Top line" = revenue; "bottom line" = net income. The exam uses these terms interchangeably with the formal names.
What Do EBITDA, EBIT, and EBT Show?
| Measure | Formula | What It Shows |
|---|---|---|
| EBITDA | Net income + Interest + Taxes + Depreciation + Amortization | Operating cash flow proxy; removes effects of financing and accounting decisions |
| EBIT (Operating Income) | Revenue - COGS - Operating expenses (or Net income + Interest + Taxes) | Operating profitability before financing costs |
| EBT | EBIT - Interest expense (or Net income + Taxes) | Pre-tax profitability |
| Net income | Revenue - All expenses (including taxes) | Bottom-line profitability |
- EBITDA is useful for comparing companies with different capital structures and depreciation policies
- EBIT isolates the core business performance from financing decisions
- Moving down the income statement, each measure includes more expense categories
- You can build EBIT and EBT working down from revenue, or backward up from net income; the exam may give either starting point
Exam Tip: Gotchas
- EBITDA adds back depreciation and amortization to approximate operating cash flow, but it is NOT actual cash flow from operations.
- Interest expense comes AFTER operating income (EBIT); it is a financing cost, not an operating cost.
How Do Basic and Fully Diluted EPS Differ?
EPS is one of the most widely followed metrics for evaluating a company's profitability on a per-share basis.
Basic EPS
- Basic EPS = (Net income − preferred dividends) / Weighted average common shares outstanding
- Uses only shares that are currently issued and outstanding
Fully Diluted EPS
- Fully diluted EPS = (Net income − preferred dividends) / (Weighted average common shares + All potentially dilutive securities)
- Dilutive securities include:
- Convertible bonds
- Convertible preferred stock
- Stock options
- Warrants
- Fully diluted EPS is always equal to or lower than basic EPS (more shares in the denominator)
- Gives the worst-case (most conservative) EPS figure
Exam Tip: Gotchas
- Fully diluted EPS assumes ALL convertible securities and options are exercised. This gives the lowest possible EPS figure.
- The exam may ask which securities dilute EPS - the answer includes convertible bonds, convertible preferred, options, and warrants.
- If a question asks for the "most conservative" EPS measure, it wants fully diluted.
- Fully diluted EPS can never be HIGHER than basic EPS - it can only be equal or lower.
What Should You Check on Exam Day?
- Revenue is the top line; net income is the bottom line.
- EBITDA adds back interest, taxes, depreciation, and amortization; it approximates cash flow but is not actual cash flow.
- Interest expense is a financing cost that comes after EBIT, not an operating cost.
- Basic EPS = (Net income - preferred dividends) / weighted average common shares outstanding.
- Fully diluted EPS assumes every convertible bond, convertible preferred share, option, and warrant is exercised, so it is always the most conservative (lowest) EPS figure.