Key Insight
The income statement answers one question: what did this business earn during this period? The answer requires reading every line — not just the bottom line.
The Income Statement Structure
Revenue (top line): Total sales or service revenue before any deductions
Cost of Goods Sold (COGS): Direct costs of delivering products or services — materials, direct labor, subcontractors
Gross Profit: Revenue minus COGS — what the business earns before overhead
Operating Expenses (SG&A): Selling, general, and administrative expenses — rent, salaries (including owner), utilities, insurance, marketing
Operating Income (EBIT): Gross profit minus operating expenses
Interest Expense: Financing costs on business debt
Taxes: Federal, state, and local income taxes (for C-corps; pass-through entities show minimal entity-level tax)
Net Income: The bottom line
What Buyers Focus On
In SMB acquisitions, the income statement is analyzed primarily to:
- Calculate gross margin and identify cost structure
- Identify and document add-backs for SDE normalization
- Verify consistency of expenses year-over-year
- Detect unusual line items that warrant investigation
Reading Between the Lines
Line items that should prompt questions:
- "Outside services" or "contractors": Could be 1099 workers; assess misclassification risk
- "Miscellaneous": Catch-all categories hide things; ask for itemization
- "Officer compensation": The starting point for the add-back analysis
- "Management fees": May be related-party payments
- Large rent relative to revenue: Above-market rent to a related party?
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