Pre-Tax Income

Pre-tax income (also called EBT — earnings before tax) is the last stop before the government gets involved. Everything above this line reflects business decisions: what you sell, what it costs to make, how you run the company, and how you finance it.

Revenue

Revenue (or "top line") is the total value of goods or services sold during the period. A critical nuance: revenue is recognized when it's earned, not when cash is collected. If you ship product in December but get paid in January, December's IS gets the revenue.

This is called accrual accounting, and it's the reason the income statement and the cash flow statement tell different stories. You'll see why that matters when we hit the CFS section.

COGS and Gross Profit

Cost of Goods Sold (COGS) captures the direct costs of producing whatever the company sells — raw materials, factory labor, manufacturing overhead. For a service firm, think salaries of the people delivering the service.

Key Formula

$Gross Profit = Revenue - COGS$

Gross margin (Gross Profit / Revenue) is the first profitability checkpoint. It answers: "For every dollar of revenue, how much is left after making the product?"

Intuition

A software company at 80% gross margin vs. a grocery chain at 25% tells you everything about their business models. Gross margin is the fastest way to compare economics across industries.

Aside

LIFO vs. FIFO impact on COGS — when prices are rising, LIFO (last-in, first-out) assigns the newest, more expensive inventory to COGS, producing higher COGS, lower gross profit, and lower taxes. FIFO (first-in, first-out) does the opposite: older, cheaper inventory flows to COGS, yielding higher gross profit but higher taxes. This is why some companies prefer LIFO in inflationary environments.

Operating Expenses

Below gross profit, you subtract the costs of running the business:

SG&A (Selling, General & Administrative): Sales commissions, marketing, rent, executive salaries, legal — everything that keeps the lights on and the product moving
R&D (Research & Development): Spending on new products, features, or technology. Heavy in pharma and tech, minimal in banking
D&A (Depreciation & Amortization): The non-cash allocation of a long-lived asset's cost over its useful life. A $10M machine depreciated over 10 years puts $1M of D&A on the IS each year

After subtracting all operating expenses from gross profit, you arrive at EBIT — also called operating income.

Aside

Operating leverage — COGS scales roughly in proportion to revenue, but much of SG&A (rent, executive salaries, back-office staff) is relatively fixed. When revenue grows, these fixed costs get spread over more dollars, so operating margins expand. This is why analysts focus on SG&A as a % of revenue — a declining ratio signals operating leverage kicking in.

EBIT vs. EBITDA

This is an interview favorite. Both measure operating profitability, but they handle D&A differently.

Metric	Includes D&A?	What It Approximates
EBIT	Yes (D&A is subtracted)	Profit from operations after accounting for asset wear
EBITDA	No (D&A is added back)	Rough proxy for operating cash flow

Key Formula

$EBITDA = EBIT + D&A$

Interview Insight

"Difference between EBIT and EBITDA?" EBITDA adds back D&A to EBIT. D&A is non-cash, so EBITDA is a closer proxy for operating cash generation. It also makes companies with different capital intensity more comparable.

Above the Line vs. Below the Line

This distinction shapes how Wall Street evaluates companies. "Above the line" refers to operating metrics — $Gross Profit$ , $EBIT$ , $EBITDA$ , and their associated margins. These are independent of how the company is financed and are the basis for enterprise-level comparisons ( $EV/EBITDA$ , operating margin benchmarks).

"Below the line" refers to everything after non-operating items — $Net Income$ , $EPS$ , $P/E$ ratios. These metrics reflect the company's capital structure (how much debt it carries, what interest rate it pays).

Why it matters: two companies with identical operations but different debt loads will have the same EBIT but very different net incomes. Above-the-line metrics let you compare the businesses. Below-the-line metrics tell you what's left for equity holders.

Interview Insight

When an interviewer asks you to compare two companies, start above the line. Use $EV/EBITDA$ or operating margins to assess the business itself. Only move below the line when the question is specifically about returns to equity.

Non-Operating Items

Below EBIT, you encounter items that have nothing to do with day-to-day operations:

Interest expense: The cost of carrying debt. A company with more leverage will have higher interest expense, pushing EBT lower even if EBIT is identical to a competitor's
Interest income: Cash earned on deposits or investments — usually small for non-financial companies
Other income / expense: Gains or losses on asset sales, foreign currency impacts, write-downs, or one-time items

Subtract net interest and other items from EBIT and you land on EBT (pre-tax income).

Key Formula

$EBT = EBIT - Interest Expense + Interest Income \pm Other$

Key Takeaways

Revenue is recognized when earned, not when cash arrives — this is the core of accrual accounting
Gross margin reveals product-level economics and is the go-to metric for cross-industry comparisons
EBIT includes D&A; EBITDA adds it back — interviewers want you to explain why (non-cash, comparability)
Above the line (EBIT, EBITDA, operating margin) isolates the business; below the line (net income, EPS) reflects financing decisions — know which to use and when
Non-operating items (interest, other income) sit between EBIT and EBT and reflect financing choices, not operational performance

IS Overview Tax