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Set out the parts that make up an income statement

CFA® Level I · Financial Statement Analysis · Analyzing Income Statements · FSA.1.a

The idea

The income statement reports financial performance over a period. Revenue sits at the top; subtracting cost of goods sold gives gross profit, and subtracting operating expenses gives operating profit. Below that come non-operating items, interest and taxes, ending in net income. Gains and losses arise from transactions outside ordinary activities, such as selling equipment. The key distinction from the cash flow statement: revenue is recognised when earned, not when cash arrives, so profit and cash flow routinely differ.

A practice question

From the question bank, with the reason each wrong option is wrong.

Revenue less cost of goods sold equals:

  1. gross profit — correct
  2. operating profitWhy not: That comes one step further down, after selling and administrative expenses are also deducted.
  3. net incomeWhy not: Further down again — after operating expenses, interest and tax.

Gross profit is the first subtotal. Operating expenses come out next to give operating profit, and interest and taxes after that to give net income.

A harder one

A manufacturer sells a used delivery vehicle for more than its carrying value. The excess is best described as:

  1. revenueWhy not: Revenue comes from ordinary activities. A manufacturer sells manufactured goods, not its own used vehicles, so this falls outside that.
  2. a non-operating gain — correct
  3. a reduction in cost of goods soldWhy not: COGS relates to the goods actually sold to customers. Netting a disposal against it would flatter the gross margin with something unconnected to production.

Selling vehicles is outside ordinary activities for a manufacturer, so it is a gain rather than revenue — which matters, because gains are not a repeatable source of earnings.

The hardest tier

Two otherwise identical firms differ only in that one is financed largely by debt. Which measure will differ most between them?

  1. Gross profitWhy not: It sits above interest entirely — it is revenue less cost of goods sold, and capital structure touches neither.
  2. RevenueWhy not: Revenue is what customers paid. How the firm financed itself does not change that.
  3. Net income — correct

Interest expense sits below operating profit, so it depresses net income for the leveraged firm while leaving revenue and gross profit untouched.

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