What does the income statement measure?
The income statement, or statement of profit or loss, summarizes the business's performance over a period: how much revenue it earned, how much it spent to earn it, and what was left. It is prepared on the accrual basis, so revenue is recorded when earned, not when collected.
The real value of the statement lies in its layers: each level of profit answers a different question.
A complete statement for a trading business
Income statement of a building materials company for the year ended 31 December 2025 (in SAR):
| Item | Amount | % of net sales |
|---|---|---|
| Gross sales | 3,200,000 | |
| Less: sales returns and discounts | (200,000) | |
| Net sales | 3,000,000 | 100% |
| Cost of sales | (2,100,000) | 70% |
| Gross profit | 900,000 | 30% |
| Selling and distribution expenses | (250,000) | 8.3% |
| General and administrative expenses | (300,000) | 10% |
| Operating profit | 350,000 | 11.7% |
| Other income | 20,000 | |
| Finance costs | (50,000) | |
| Profit before Zakat | 320,000 | 10.7% |
| Zakat | (25,000) | |
| Net profit for the year | 295,000 | 9.8% |
The Zakat amount here is hypothetical for the purposes of the example; Zakat is calculated on the Zakat base, not on profit alone.
Reading the layers one by one
Net sales
The correct starting point is net sales after returns and discounts, excluding VAT, because VAT is a liability to ZATCA, not revenue. Returns of more than 6% of gross sales, as in the example, deserve a question: is it a quality problem, or a lenient returns policy?
Cost of sales and gross profit
In a trading business: cost of sales = opening inventory + net purchases + purchasing costs (freight, customs) - closing inventory. So if opening inventory is 450,000, purchases are 2,250,000 and closing inventory is 600,000, the cost is 2,100,000 SAR.
Gross profit measures the efficiency of pricing and purchasing. A 30% margin means every 100 SAR of sales leaves 30 SAR to cover expenses and profit.
Operating expenses and operating profit
Selling expenses include sales representatives' salaries and commissions, advertising and delivery to customers. Administrative expenses include management salaries, office rent, telecommunications, professional fees and depreciation not related to selling. Operating profit shows what the core activity earns before the effect of how it is financed.
Non-operating items and Zakat
Other income, such as gains on the sale of an asset, and finance costs, such as loan commissions, are presented after operating profit. Then Zakat is deducted for Saudi and GCC shareholdings, or income tax at 20% of adjusted net profit for non-Saudi, non-GCC shareholdings, to arrive at net profit.
Questions to ask of every income statement
- Did gross profit grow at the same rate as sales, or did the margin erode because of discounts or higher costs?
- Are administrative expenses roughly fixed, or growing faster than sales?
- How much of the profit comes from non-recurring items? A gain on selling an old car does not recur every year.
- Are finance costs eating up a large part of operating profit? In the example they represent about 14%.
Comparing two years: where is the story hiding?
A single year's statement is not enough to judge. Suppose the same company achieved net sales of 2,500,000 SAR and gross profit of 800,000 SAR in 2024, a margin of 32%. In 2025 sales grew 20% to 3,000,000, but the margin fell to 30%.
| Item | 2025 | 2024 | Change |
|---|---|---|---|
| Net sales | 3,000,000 | 2,500,000 | +20% |
| Gross profit | 900,000 | 800,000 | +12.5% |
| Gross profit margin | 30% | 32% | -2 points |
Had the company kept a 32% margin on its 2025 sales, gross profit would have been 960,000 SAR. In other words, a drop of just two points cost it 60,000 SAR, roughly one fifth of net profit. Possible causes: larger discounts to win new customers, higher supplier prices without adjusting selling prices, or a shift in the sales mix toward less profitable items. This kind of analysis is what turns the income statement from a document for the auditor into a tool for managing the business.
The next step after the comparison is to break gross profit down by item group or branch. You may discover that a single item makes up a third of sales at a margin of no more than 15%, while other items with lower sales earn margins above 40%. That information alone may change next year's purchasing plan, pricing and promotions.