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Chapter 3 · Day 3 — The income statement

From revenue to EPS, line by line

Five profit numbers sit between sales and earnings per share. Each strips out a different cost, and each tells you something the others cannot.

3 of 30 · 14 min

There is no single 'profit'. There are five, stacked, and an analyst who quotes one without saying which is not saying much.

From revenue to earnings per share

Revenue− Cost of goods sold= Gross profit− Operating expenses= Operating profit (EBIT)− Interest − Tax= Net profit → EPSwidest bar = revenuewhat shareholders own
Each step subtracts a different kind of cost. A company can look healthy at the top and thin at the bottom, which is why margin is read at every level rather than only at the end.

The formulas

MetricFormulaStrips out
Gross profitRevenue − COGSCost of making the product
Operating profit (EBIT)Gross profit − Operating expensesRunning the business
EBITDAEBIT + Depreciation + AmortisationNon-cash charges
Profit before taxEBIT − InterestCost of debt
Net profitPBT − TaxGovernment's share
EPSNet profit ÷ Weighted average sharesDilution across the year

Worked example — Illustrative Example, Himal Foods Ltd

LineRs '000Margin
Revenue1,20,000100%
Cost of goods sold(74,400)
**Gross profit****45,600****38.0%**
Operating expenses(27,600)
**Operating profit (EBIT)****18,000****15.0%**
Depreciation (in opex)4,800
**EBITDA****22,800****19.0%**
Interest(4,200)
**Profit before tax****13,800****11.5%**
Tax at 25%(3,450)
**Net profit****10,350****8.6%**

Shares outstanding, weighted average: 90,00,000. EPS = 1,03,50,000 ÷ 90,00,000 = Rs 11.50.

What each margin is telling you

MarginHigh suggestsLow suggestsException
GrossPricing power, cheap inputsCommodity product, cost pressureMeaningless for banks — no COGS
OperatingCost control, scaleOverheads eating the grossRises with scale, so young firms look worse
EBITDACash-generative operationsWeak core economicsIgnores the cost of the assets — dangerous for capital-heavy firms
NetWhole system worksDebt or tax is taking itDistorted by one-off gains

Common mistakes

  • Comparing net margin across sectors — a bank and a retailer are not comparable on this line.
  • Treating one-off gains (asset sales, revaluations) as ordinary earnings.
  • Missing that EPS grew only because the share count fell, or fell only because bonus shares were issued.

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