$20,000 came in. How much was profit?
The story so far Your tune-up business is now an LLC with a small shop. In its first full year you did 500 tune-ups at $40: $20,000 of sales. It felt like a lot. But there were parts, $800 a month of rent, insurance, ads, a tool kit and a small loan. The bank wants to see how the year went before it lends you more. So you need the one page every business uses to answer "did we make money?": the income statement.
An income statement lists what a business earned and what it spent over a period, like a year, and ends with its profit.
Banks, investors and owners all read it first. It shows not just whether a business made money, but where the money went.
Start with sales at the top, subtract costs in a fixed order, and read the profit at the bottom.
Accountants prepare it. Bankers and credit analysts use it to decide on loans. Equity research analysts on Wall Street study public companies' income statements every quarter.
What you're looking at: the shape of an income statement. Sales sit at the top, called the top line. Each cost below gets subtracted. What's left at the bottom is net income, the bottom line: $2,800 out of $20,000.
From the top line to the bottom line.
An income statement always goes in the same order, so you can read anyone's, from a lemonade stand to Apple. Each step subtracts one kind of cost.
Revenue
Revenue is everything you earned from sales. It's the first line, so people call it the top line. Like profit in Lesson 11.2, revenue counts a sale when you do the work, even if the customer pays later.
- Revenue
- 500 tune-ups × $40 = $20,000.
Cost of goods sold and gross profit
Cost of goods sold (COGS) is the direct cost of what you sold, like the variable costs from Lesson 11.1. Subtract it from revenue to get gross profit. Divide gross profit by revenue for the gross margin.
- COGS
- Parts: 500 × $10 = $5,000.
- Gross profit
- $20,000 − $5,000 = $15,000.
- Gross margin
- $15,000$20,000 = 0.75, so 75%.
Operating expenses
Operating expenses are the costs of running the business that don't go up with each sale, like the fixed costs from Lesson 11.1: rent, insurance, ads and salaries.
- Rent
- 12 × $800 = $9,600.
- Insurance and small tools
- $1,200.
- Ads
- $600.
Depreciation
When you buy something that lasts for years, like a machine or a truck, you don't count the whole price as a cost in the year you buy it. You spread it over the years it'll be used. That yearly slice is depreciation, and it's an operating expense. The cash left all at once; the expense shows up a little each year.
- A $3,000 repair stand and tool kit
- It should last 5 years: $3,0005 = $600 a year.
- Total operating expenses
- $9,600 + $1,200 + $600 + $600 = $12,000.
Operating income
Operating income is what the business itself earns from its main work. Wall Street often calls it EBIT, earnings before interest and taxes. The operating margin is operating income divided by revenue.
- Operating income
- $15,000 − $12,000 = $3,000.
- Operating margin
- $3,000$20,000 = 0.15, so 15%.
Interest, taxes and net income
Next come the costs of how the business is paid for and taxed. Interest on loans is an expense, but paying back the loan itself, the principal, is not: that's just returning borrowed money. Then income tax: a C corporation pays 21% here, while a pass-through LLC shows $0, because the owner pays on a personal return (Lesson 11.3). What's left is net income, the bottom line. The net margin is net income divided by revenue.
- Interest
- On a small equipment loan: $200.
- Taxes
- Your LLC is pass-through: $0 on this statement.
- Net income
- $3,000 − $200 − $0 = $2,800.
- Net margin
- $2,800$20,000 = 0.14, so 14%: 14 cents of every dollar.
What you're looking at: your shop's income statement for the year. Each bar shows the line as a share of revenue: green for revenue, orange for costs, blue for profit lines. Parts cost $10 a tune-up; rent, insurance, ads and depreciation stay at $12,000; interest stays at $200. Switch to C corp to see a 21% tax line.
Two minutes. Just listen.
Tap any line to jump to it.
Line it up.
Eight questions about income statements from small businesses. Each one gives you the numbers. One try each.
What you're looking at: made-up businesses. Each lists a few numbers from its year, then asks one question.
The logic, step by step.
Every income statement is the same four subtractions.
Step 1: Revenue minus direct costs
- Gross profit
- $20,000 − $5,000 = $15,000.
Step 2: Minus the cost of running the place
- Operating income
- $15,000 − $12,000 = $3,000.
Step 3: Minus interest and taxes
- Net income
- $3,000 − $200 − $0 = $2,800.
Step 4: Turn each profit into a margin
- Margins
- Gross 75%, operating 15%, net 14%.
Worked example: what if it were a corporation?
- Same business. Pre-tax income is $3,000 − $200 = $2,800.
- Corporate tax. $2,800 × 0.21 = $588.
- Net income. $2,800 − $588 = $2,212.
- Net margin. $2,212$20,000 = 0.1106, about 11%.
- The lesson. Everything above operating income is the same. Only the lines below it change with how the business is set up and paid for. That's why analysts compare companies on operating income.
Trees have a gross and a net, too.
Ecologists measure plants the same way accountants measure businesses. Everything a plant makes from sunlight is its gross production. It burns a big share of that, often about half, just to stay alive. What's left over, the net production, is what becomes new wood, leaves and seeds.
What you're looking at: an illustration, not data. Sunlight comes into a tree on the left, some energy goes out as the tree's own upkeep at the top, and the rest becomes a new growth ring, shown in green on the right.
Why this sticks. A big tree in the sun can still grow slowly if its upkeep is high. A business with big revenue can still earn little if its costs eat the top line. Always read down to the net.
The page you'd copy down.
- Revenue (top line): 500 × $40 = $20,000.
- − COGS = gross profit: $20,000 − $5,000 = $15,000 (75% gross margin).
- − Operating expenses (rent, insurance, ads, depreciation) = operating income / EBIT: $15,000 − $12,000 = $3,000 (15%).
- Depreciation = priceyears used. $3,0005 = $600 a year.
- − Interest − taxes = net income (bottom line): $3,000 − $200 − $0 = $2,800 (14%). Loan principal is not an expense.
- C corporation: 21% tax. $2,800 × 0.21 = $588, net $2,212.
Fill in the blanks
Grab a friend or a study group.
Build one
Pick a business you both know, like a pizza place. Guess its revenue, COGS and operating expenses for a year. Whose net margin is more believable?
Read a real one
Look up a public company's income statement on a finance website. Find revenue, gross profit, operating income and net income. Work out each margin.
Slider challenge
Using the statement above, what's the fewest tune-ups at $40 that keeps net income above zero? What about at $50?
Just you and your money.
These stay on this device. Nobody else sees them.
Exam-style questions.
Written the way a college exam would ask them. Each right answer on the first try is worth 10 xp.
On the job: you're an equity research analyst
You cover Trailhead Gear, a company that sells hiking gear. It's a C corporation. Here's its year:
- Revenue: $5,000,000.
- Cost of goods sold: $3,000,000.
- Operating expenses: $1,500,000.
- Interest: $100,000.
- Tax rate: 21%.
Your task: work out gross profit, operating income and net income, and the gross and net margins. A rival has a 50% gross margin. What might explain the difference?
See a model answer
Gross profit: $5,000,000 − $3,000,000 = $2,000,000. Gross margin: $2,000,000$5,000,000 = 40%.
Operating income: $2,000,000 − $1,500,000 = $500,000 (10%).
Net income: $500,000 − $100,000 = $400,000 before tax. Tax: $400,000 × 0.21 = $84,000. Net income: $316,000. Net margin: $316,000$5,000,000 = 6.32%.
The gap: the rival keeps 50 cents of each sales dollar after direct costs; Trailhead keeps 40. The rival might charge higher prices for a stronger brand, buy its gear more cheaply, or sell more of its own products instead of other brands'.
The first of three statements.
What you're looking at: a map of where this lesson fits in the course. Read it left to right: the lessons it builds on, this lesson in the middle, and the lesson that comes next.
- Back · Unit 11Will your business make money?
- Back · Unit 11Profitable and still broke
- Back · Unit 11Making it official
- You are hereDid the business make money?
- Next · Unit 12What it owns, what it owes