Good work mastering the Balance Sheet. The Balance Sheet is a snapshot of the business at the end of the period, but the Income Statement is a video that shows everything that happens over the period, say a month or a year. Hit play and see how a company actually makes money.
If December 31 is a snapshot of your wealth (the Balance Sheet), then January 1 onwards is the story of how you got there (the Income Statement). Often referred to as the Profit and Loss statement (or P&L), the Income Statement is the most popular financial report for managers. This is because it gives them the answer to one simple question: Did we make profit? An Income Statement reads like a story going from top to bottom.
The tale nearly invariably begins with Revenue (also referred to as Sales). The overall revenue generated from selling your product or service is known as sales. When a business leader speaks about “Top-Line Growth,” it basically means growing sales.
In order to make money, you need to spend money. As you go down the page, expenses will be deducted from your revenue. First, we deduct direct expenses (for example, the cost of raw materials) from revenue to find Gross Profit. Next, we subtract Operating Expenses (like rent, marketing, and salaries) to find Net Income (or Net Profit).
Once you have settled your invoices for the materials, your employees, your rent, and your taxes, whatever is left at the very bottom of the page is your Net Income (or Net Profit).
\[ \text{Net Income} = \text{Revenue} - \text{Expenses} \]When executives say, “We need to protect the bottom line,” they mean we need to defend this final profit number. In other words, they either need to increase the top line (sell more) or shrink the middle (cut expenses).
ABC Company
Income Statement
For the Period Ended 31 December 2025
| $ | |
|---|---|
| Revenue: Money coming in from Sales | 100,000 |
| Less: Direct cost: Cost of making the product i.e. Raw materials | (40,000) |
| Gross Profit: Profit before paying the bills | 60,000 |
| Less: Operating Expenses: The cost of running the business i.e. Rent, Salaries, Marketing | (45,000) |
| Net Income: What is left over for the owners | 15,000 |
You can now see how the company earns a profit from its sales! Having a paper profit doesn't mean you have cash in the bank. In our final lesson on the Cashflow statement, we will look at where the real money is hiding. It is time for a little exercise!