The Top Line vs Bottom Line

Understanding the Different Types of Figures on an Income Statement

Bottom Line Profit
Fundamentals are based upon earnings and assets. When people refer to "the bottom line", they're talking about profits. Comstock / Stockbyte / Getty Images

If you work in business or investing, you might hear someone refer to something as being either "top line" or "bottom line".  What do these terms mean?  How does the top line differ from the bottom line and why should you, or anyone else, care?  Sooner or later, you're going to need to know the answer to those questions, especially if you want to be successful in life so it might as well be right now.

 A lot of people have enjoyed affluence only to lose it all because they didn't understand that the two do not necessary move in tandem and that, in most cases, sustainable success requires mastering both.  

Let me walk you through a brief introduction to both concepts and break down for you how they differ.

The Phrases Top Line and Bottom Line Refer to Line Items on an Income Statement

If you read my step-by-step lesson teaching you how to analyze an income statement, you may recall that every income statement, or Profit and Loss or P&L as they are sometimes known, is broken down into sections.  At the top, you begin with sales or revenue, which generally refers to the money a company generated by providing goods or services to its customers.  As you go further down the income statement, different amounts are taken out or, in some cases, added, to reflect different types of expenses or income.

 You finally arrive at the bottom, where you find a figure known as net income applicable to common shares, which is the profit the stockholders are entitled to enjoy after backing out things like costs, interest expense, taxes, minority stakes, etc.  It is that figure that is used to calculate something known as basic and diluted earnings per share.

When you hear someone refer to the "top line", they are usually referring to sales or net sales (the latter is sales adjusted for certain items).  If you owned a Cinnabon franchise, for example, the top line is going to be how much cash you brought in from selling cinnamon rolls and cups of coffee.  If you hear someone refer to the "bottom line", they are usually referring to the net income applicable to common shares (though some small business owners will use this to refer to the pre-tax operating earnings so clarify the context).  For example, if you hear an investor talk about the bottom line results at a company like Colgate-Palmolive, they are talking about the actual after-tax profits.

Beyond that, there are some other terms and profitability concepts you should know if you really want to become comfortable with this sort of thing.  One illustration: When an executive, analyst, investor, or business owner talks about profits, he or she may be referring to one of three different types of profit:

  • Net Profit - This is the bottom-line profit after all expenses, taxes, interest, and other costs have been paid, depreciation estimated, and the books closed.  You can read more about net profit here.

Furthermore, when a person refers to gross profit, operating profit, or net profit, they may be referring to the actual figure expressed in a given currency (e.g., "The bottom line for the year?  We made $1.2 million in profit.") or they may be referring to a relative financial ratio known as a profit margin.  Specifically, they may be referring to the gross profit margin, operating profit margin, and net profit margin, which tell you how large each of those different types of profit are compared to overall revenue.  These topics are also discussed in the links attached to each of the bullet points in the previous paragraph if you want to learn more about them.

Once You Have Different Profit and Profit Margin Figures, You Can Use Them To Do Basic Valuation Analysis

After you have the top line and bottom line figures, you can go one step further and start using those to perform some basic valuation on different companies.  Earlier today, I updated an older article called Peter Lynch's Secret Formula for Valuing a Stock's Growth, which broke out three different valuation multiples that a person can use to try and compare how "expensive" one company is to another, at least on a first-pass basis. 

The three metrics included in that article are the p/e ratio, which tells you how expensive a company is relative to its net income, the PEG ratio, which attempts to adjust the p/e ratio for growth in the underlying profits, and the dividend-adjusted PEG ratio, which goes even one step further than that and attempts to factor in not only growth, but dividend income given its role in generating total return.

Beware of a Certain Type of "Profit" Known as EBITDA

EBITDA stands for earnings before interest, taxes, depreciation and amortization. In essence, it is the amount of money that would have been made if a company did not pay interest charges, taxes, depreciation, and amortization. By now you should be asking yourself, "How can you ignore those costs? They still exist even if you pretend they don't!"

Exactly. This is sort of like pretending that the interest you pay on your credit cards, your income taxes, and the depreciation on your car aren't real expenses to you. According to the EBITDA standards, they don't exist. If you can't tell, although you will hear a lot of professionals talking about this number, it is one of the most worthless, deceitful and meaningless figures available. Most investors are best served by paying absolutely no attention to it.

Things To Keep In Mind About Top Line and Bottom Line Profits

Whether you are an investor, manager, lender, or business owner, there are a few takeaways you need to remember about the top line and bottom line profit figures.

First, it is possible for an enterprise to increase the top line (sales) while decreasing the bottom line (net earnings).  Not all sales are profitable.  There are companies that have gone broke because their sales increased too rapidly.

Second, it is possible for an enterprise to decrease the top line (sales) while increasing the bottom line (net earnings).  Through cost cutting, automation, and structural changes in the business, certain firms have been able to mint money even in declining sectors and industries, making their shareholders rich.

Third, remember that, generally, the ideal situation is one in which the top line and the bottom line are growing in tandem.  However, most businesses have something known as operating leverage built into them.  I talked about this a bit when I taught you about something known as the interest coverage ratio but, basically, there is a certain level of fixed expenses in the business - the rent, the payroll for employees, keeping the lights on and the water running - that eat up a lot of profit below a certain top line figure.  Once this is crossed, a huge percentage of the additional sales above that magic line drop straight to the bottom line.  Those incremental sales, in other words, are far more profitable.  An intelligent investor can make a lot of money buying into a bad business that is about to turnaround, in effect harnessing the fact that an increase of [x]% in the top line can result in an increase of [10x]% in the bottom line.