# How Microsoft makes money

CXProWealth Business Lens · Microsoft (MSFT) · Q1 FY2027

Read from the 10-Q for the period 2026-07-01 to 2026-09-30, filed 2026-10-28 with the SEC (accession 0001193125-26-436133): https://www.sec.gov/Archives/edgar/data/789019/000119312526436133/

Business Lens explains how a company earns, spends and keeps its money, from its own filings. It is insight and context, never a view on the shares, a target, or advice. Figures are raw units as filed; percentages are percentage points.

## Headline figures

- Revenue: $92.3B (+18.8% on the year)
- Operating income: $45.9B (operating margin 49.8%)
- Net income: $36.6B (net margin 39.7%)
- Gross margin: 67.8%
- Free cash flow: $18.6B (20.2% of revenue)
- Cash conversion (operating cash flow / net income): 1.58x
- Capital expenditure: 42.7% of revenue

## Where the money goes (Q1 FY2027)

- Azure → Revenue: $33.2B
- Microsoft 365 cloud → Revenue: $27.8B
- Productivity and server licensing → Revenue: $8.4B
- Search and advertising → Revenue: $6.6B
- Xbox → Revenue: $5.4B
- Industry solutions → Revenue: $5.3B
- Windows OEM and devices → Revenue: $3.6B
- Frontier and support services → Revenue: $2.1B
- Revenue → Cost of revenue: $29.7B
- Revenue → Gross margin: $62.6B
- Gross margin → Research and development: $9.0B
- Gross margin → Sales and marketing: $5.7B
- Gross margin → General and administrative: $1.9B
- Gross margin → Operating income: $45.9B
- Operating income → Income before income taxes: $45.9B
- Other income (expense), net → Income before income taxes: $38.0M
- Income before income taxes → Provision for income taxes: $9.3B
- Income before income taxes → Net income: $36.6B

## Where the revenue comes from

### Products and services (Revenue Classified by Significant Product and Service Offerings (Detail))

| Member | Value | Share |
|---|---:|---:|
| Azure | $33.2B | 35.9% |
| Microsoft 365 cloud | $27.8B | 30.1% |
| Productivity and server licensing | $8.4B | 9.1% |
| Search and advertising | $6.6B | 7.1% |
| Xbox | $5.4B | 5.8% |
| Industry solutions | $5.3B | 5.8% |
| Windows OEM and devices | $3.6B | 3.8% |
| Frontier and support services | $2.1B | 2.3% |

The members sum to total revenue.

### Segments (Segment Revenue, Cost of Revenue, Operating Expenses and Operating Income (Detail))

| Member | Value | Share |
|---|---:|---:|
| Agents and Infra | $76.8B | 83.2% |
| Devices and Consumer | $15.5B | 16.8% |

The members sum to total revenue.

## Income statement, as filed

| Line | Q1 FY2027 | Of revenue |
|---|---:|---:|
| Revenue | $92.3B | 100% |
|   Product | $14.6B | 15.9% |
|   Service and Other | $77.6B | 84.1% |
| Cost of revenue | $29.7B | 32.2% |
|   Product | $2.5B | 2.7% |
|   Service and Other | $27.2B | 29.5% |
| **Gross margin** | $62.6B | 67.8% |
| Research and development | $9.0B | 9.8% |
| Sales and marketing | $5.7B | 6.2% |
| General and administrative | $1.9B | 2.0% |
| **Operating income** | $45.9B | 49.8% |
| Other income (expense), net | $38.0M | 0.0% |
| **Income before income taxes** | $46.0B | 49.8% |
| Provision for income taxes | $9.3B | 10.1% |
| **Net income** | $36.6B | 39.7% |
| Basic | $5 | 0.0% |
| Diluted | $5 | 0.0% |
| Basic | 7,426,000,000 |  |
| Diluted | 7,446,000,000 |  |

## History

| Period | Revenue | Operating income | Net income | Operating cash flow | Capital expenditure | Free cash flow |
|---|---:|---:|---:|---:|---:|---:|
| FY2008 | $60.4B | $22.3B | $17.7B | $21.6B | $3.2B | $18.4B |
| FY2009 | $58.4B | $20.4B | $14.6B | $19.0B | $3.1B | $15.9B |
| FY2010 | $62.5B | $24.1B | $18.8B | $24.1B | $2.0B | $22.1B |
| FY2011 | $69.9B | $27.2B | $23.2B | $27.0B | $2.4B | $24.6B |
| FY2012 | $73.7B | $21.8B | $17.0B | $31.6B | $2.3B | $29.3B |
| FY2013 | $77.8B | $26.8B | $21.9B | $28.8B | $4.3B | $24.6B |
| FY2014 | $86.8B | $27.8B | $22.1B | $32.5B | $5.5B | $27.0B |
| FY2015 | $93.6B | $18.2B | $12.2B | $29.7B | $5.9B | $23.7B |
| FY2016 | $91.2B | $26.1B | $20.5B | $33.3B | $8.3B | $25.0B |
| FY2017 | $96.6B | $29.0B | $25.5B | $39.5B | $8.1B | $31.4B |
| FY2018 | $110.4B | $35.1B | $16.6B | $43.9B | $11.6B | $32.3B |
| FY2019 | $125.8B | $43.0B | $39.2B | $52.2B | $13.9B | $38.3B |
| FY2020 | $143.0B | $53.0B | $44.3B | $60.7B | $15.4B | $45.2B |
| FY2021 | $168.1B | $69.9B | $61.3B | $76.7B | $20.6B | $56.1B |
| FY2022 | $198.3B | $83.4B | $72.7B | $89.0B | $23.9B | $65.1B |
| FY2023 | $211.9B | $88.5B | $72.4B | $87.6B | $28.1B | $59.5B |
| FY2024 | $245.1B | $109.4B | $88.1B | $118.5B | $44.5B | $74.1B |
| FY2025 | $281.7B | $128.5B | $101.8B | $136.2B | $64.6B | $71.6B |
| FY2026 | $331.8B | $155.2B | $133.7B | $182.9B | $115.9B | $67.0B |

Latest trend (the newest full year against the year before; a reading, not a forecast):

- Revenue: +17.8% (year before +14.9%): accelerating
- Operating income: +20.8% (year before +17.4%): accelerating
- Net income: +31.3% (year before +15.5%): accelerating
- Free cash flow: -6.5% (year before -3.3%): slowing

## Key insights

### Free cash flow has fallen to half of net income

Capital spending of $39.4B took 67.9% of operating cash flow, leaving free cash flow of $18.6B, down from $25.7B, only 50.9% of net income.

Operating cash flow rose to $58.0B from $45.1B a year earlier, but capital expenditure roughly doubled to $39.4B from $19.4B. Capital spending used 67.9% of operating cash against 43.0% a year earlier, and free cash flow fell to $18.6B from $25.7B. Capital spending equalled 42.7% of revenue, against 25.0%. _(from the filing)_
The shift has built over years. Seven years before the last fiscal year, free cash flow was $38.3B against net income of $39.2B, nearly all of it. Last fiscal year capital spending was $115.9B against operating cash flow of $182.9B, and free cash flow was $67.0B: about half of net income of $133.7B, and below the $74.1B of two years before. _(from the filing)_
Read as analysis: reported profit no longer describes the cash the business keeps. The gap is the data-center program, which turns today's cash into equipment that is expensed over many years through depreciation. Net income measures the earning power of the installed base; free cash flow shows how much of it is being reinvested. _(analysis)_
Single quarters are a noisy read: free cash flow was $5.9B three quarters ago and $18.6B this quarter. The annual figures show the same direction as the quarter. _(from the filing)_

### Operating margin rose while gross margin fell

Cost of revenue grew 23.6% and gross margin slipped 1.25 points, yet operating costs grew slowly enough to lift operating margin 0.88 points to 49.8%.

Revenue grew 18.8% to $92.3B while cost of revenue grew 23.6% to $29.7B, so gross margin fell to 67.8% of revenue from 69.0% a year earlier. Gross margin in dollars rose 16.65%, slower than revenue. _(from the filing)_
Below gross margin the costs moved the other way. Sales and marketing was $5.7B, the same as a year earlier, and fell to 6.2% of revenue from 7.4%. Research and development grew 11.1% to $9.0B and general and administrative 4.15% to $1.9B. Operating income rose 21.0% to $45.9B, faster than revenue. _(from the filing)_
Read as analysis: the two halves of the income statement tell different stories. Running the cloud costs more per dollar of revenue as new capacity enters cost of revenue, while selling it costs less, because new services are added to enterprise agreements Microsoft already holds. The filing text supplied here does not attribute either move, so the reasons are our reading. _(analysis)_
Against the prior quarter, gross margin rose to 67.8% from 67.2%, after falling in each of the three quarters before that from 69.0% a year ago. The prior quarter is derived from annual and nine-month totals rather than reported on its own. _(from the filing)_

### Net income outgrew operating income on an investment swing

Net income rose 32.0% against 21.0% for operating income, because other income moved from a $3.66B net expense to $38 million.

A year earlier other income (expense), net was a net expense of $3.66B, equal to 9.6% of operating income. This quarter it was $38 million of income. Income before income taxes therefore rose 34.0% to $46.0B while operating income rose 21.0%. The tax provision rose 42.3% to $9.3B, 20.3% of pre-tax income against 19.1%, which narrowed but did not close the gap. _(from the filing)_
The filing records impairments and changes in the fair value of investments in this line. It accounts for its stake in OpenAI by the equity method, recognising income or loss as the change in what it would receive if OpenAI's net assets were distributed at book value. _(from the filing)_
The line moves a lot. Three quarters ago net income of $38.5B was larger than operating income of $38.3B. _(from the filing)_
Read as analysis: the 21.0% operating growth is the measure of the business; the extra growth in net income came from a line that can reverse. Comparing net income across quarters without separating that line can overstate or understate the trend. _(analysis)_

### Azure gained share while every other line lost it

Azure grew 48.2% to $33.2B, now larger than the Office cloud subscriptions at $27.8B, and its share of revenue rose 7.12 points to 35.9%.

Azure, the business that rents out computing and AI infrastructure, brought in $33.2B, 35.9% of revenue. Cloud subscriptions to the Office suite and related apps added $27.8B, 30.1% of revenue, growing 17.2%, slightly behind the company's 18.8%. _(from the filing)_
Every other line lost share. Productivity and server licensing fell 3.1% to $8.4B, Windows OEM and devices fell 22.0% to $3.6B and Xbox fell 2.3% to $5.4B, while search and advertising grew 10.3% and industry solutions 9.05%, both slower than revenue. _(from the filing)_
Read as analysis: the revenue mix is moving toward the line that needs the most capital. Azure's growth and the rise in capital spending are two sides of the same build, which is why the share shift and the fall in free cash flow belong in one picture. _(analysis)_

### Competitive edge

- **Subscriptions are replacing one-time licenses** Office cloud subscriptions grew 17.2% to $27.8B while licensing sold outside the cloud fell 3.1% to $8.4B, so more revenue now renews by default.
- **The enterprise segment earns a 52.8% operating margin** Agents and Infra brought 83.2% of revenue but 88.3% of operating income, at a 52.8% margin against 34.6% for Devices and Consumer.
- **Operating cash still pays for the build** Operating cash flow of $58.0B covered capital spending of $39.4B with $18.6B left over, so the build is paid for with cash the business generates.

### What to watch

- **New capacity has to fill at prices that hold** Capital spending reached 42.7% of revenue this quarter, and last fiscal year's $115.9B compared with $44.5B two years earlier; the return depends on paying use.
- **One partner sits in revenue, receivables and investments** OpenAI is a customer, a revenue-sharing partner and an equity-method investee, so its financing and growth reach Microsoft's revenue and other income at once.
- **AI agents widen the cyber attack surface** The filing says nation-state attacks have increased and that AI and cybersecurity risks increasingly overlap and amplify one another, inside the company as well as outside.

## Operating income by segment

- Agents and Infra: $40.6B (88.3% of operating income)
- Devices and Consumer: $5.4B (11.7% of operating income)

## Investor view

**Capital spending took 42.7% of Microsoft's revenue, so free cash flow fell even as operating income grew**

### How it makes money

Microsoft earned $92.3B of revenue this quarter, up 18.8% from $77.7B a year earlier. Two cloud lines carry it. Azure, the business that rents out computing and AI infrastructure, brought in $33.2B, or 35.9% of revenue. Cloud subscriptions to the Office suite and related apps added $27.8B, or 30.1%. Together they are about two-thirds of the company. _(from the filing)_
The rest is a long tail of older franchises: productivity and server licensing sold outside the cloud at $8.4B, search and advertising at $6.6B, Xbox at $5.4B, industry solutions at $5.3B, Windows OEM and devices at $3.6B, and frontier and support services at $2.1B. _(from the filing)_
The filing reports two segments. Agents and Infra had $76.8B of revenue, 83.2% of the total, and $40.6B of operating income, 88.3% of the total, a segment margin of 52.8%. Devices and Consumer had $15.5B of revenue and $5.4B of operating income, a margin of 34.6%. The enterprise and cloud side is both the larger business and the more profitable one. _(from the filing)_
Gross margin was 67.8% of revenue and operating margin 49.8%: after research, selling and administration, almost half of every revenue dollar became operating income, $45.9B in all. Research and development is the largest operating cost at $9.0B, against $5.7B for sales and marketing and $1.9B for general and administrative. _(from the filing)_

### What shifted

Azure grew 48.2% and its share of revenue rose 7.1 points to 35.9%. Every other line lost share. Productivity and server licensing fell 3.1% and Windows OEM and devices fell 22%, while the Office-suite cloud subscriptions grew 17.2%, slightly behind the company as a whole. _(from the filing)_
Cost of revenue grew 23.6%, faster than revenue's 18.8%, so gross margin slipped 1.25 points to 67.8%. Operating costs moved the other way. Sales and marketing was flat at $5.7B and its share of revenue fell 1.17 points; research and development grew 11.1%, slower than revenue. Operating margin rose 0.88 points to 49.8%. _(from the filing)_
Net income rose 32.0% to $36.6B, faster than operating income's 21.0%. The gap is other income (expense), net, which moved from a net expense a year earlier to $38 million this quarter. That is the line where the filing records impairments and changes in the fair value of investments. The tax provision rose 42.3% to $9.3B, about 20.3% of pre-tax income against 19.1% a year earlier. _(from the filing)_
Capital expenditure was $39.4B, about twice the $19.4B of a year earlier, and 42.7% of revenue against 25.0%. Operating cash flow rose to $58.0B from $45.1B, but free cash flow fell to $18.6B from $25.7B. Free cash flow was 20.2% of revenue, far below the 49.8% operating margin. _(from the filing)_

### Risks in the filing

The risk factors lead with cybersecurity. The company says nation-state attacks on it, its customers, suppliers and partners have increased, and that attackers now use AI to automate reconnaissance, find vulnerabilities and iterate on attacks faster, shrinking the time it has to respond. It also says it may not be able to give prompt, full and reliable information about an incident while it is still investigating. _(from the filing)_
A newer risk is AI inside the company. The filing says AI models and agents with access to internal infrastructure or sensitive data may carry risks similar to highly privileged users, may take unintended actions or be manipulated by malicious inputs, and that "the risks associated with AI and cybersecurity increasingly overlap and amplify one another." _(from the filing)_
The company names security practice as a weak point: passwords not rotated, employee access not removed on time, and weaker controls at companies it has acquired or third parties it uses. It says these failures "have resulted and may result in unauthorized access" to its systems and data, including customer data. _(from the filing)_
The investment book carries its own risk. Investments are reviewed for impairment, the filing calls the judgment significant, and it states: "If market, industry, and/or investee conditions deteriorate, we may incur future impairments." One of these holdings is OpenAI, accounted for by the equity method, disclosed as a related party, with income or loss measured by the change in what Microsoft would receive if OpenAI's net assets were distributed at book value. _(from the filing)_
Of these, the numbers already show the investment exposure most clearly: the swing in other income pushed pre-tax growth well above operating growth this quarter, and a swing the other way would do the reverse. The cyber and AI-agent risks do not show in the income statement yet; they would surface first as remediation cost, outages, or lost trust in the cloud contracts that now carry the company. _(analysis)_

## Founder view: mechanisms

### Building capacity ahead of demand

Microsoft is spending on data centers, chips and power before the revenue that will use them arrives, betting that demand for AI computing is durable enough to fill them. The established software businesses fund it: their margin pays for capacity that earns over many years. The cost shows up first in cash flow, then as depreciation inside cost of revenue, and only later, if the bet is right, in revenue. _(analysis)_

### Selling new products through the existing contract

Microsoft already sits inside most large enterprises through multi-year agreements, identity, email and documents. New cloud services and AI assistants are added to those agreements instead of being sold from scratch. The cost of distribution is paid once, for the relationship, and spread across every product sold through it, which is how selling costs can stay flat while revenue grows. _(analysis)_

### Moving licenses to subscriptions

Microsoft keeps moving customers from software they buy once to services they pay for every month. A perpetual license pays once and then makes the customer decide again at upgrade time; a subscription renews by default and lets the company add features and adjust price inside the same relationship. The old line shrinks while the new one grows, and the trade is worth it because the new revenue recurs. _(analysis)_

### A partner who is also a customer and an investee

Microsoft owns a large equity stake in OpenAI, sells it computing, and shares revenue with it. One relationship lands in three places: cloud revenue, revenue-sharing payments, and the investment result below operating income. When the partner grows, Microsoft gains as supplier and as owner; when the partner loses money, part of that loss comes back through the investment line. _(analysis)_

## Member research

Signed-in members read, on the page: what Microsoft's numbers depend on from here, and the playbook behind each mechanism (what needs scale, what transfers, how to test it, the metric that would show it).

## Sources

- Microsoft 10-Q for the period to 2026-09-30: https://www.sec.gov/Archives/edgar/data/789019/000119312526436133/ (2026-10-28)

Methodology business-lens-1.0 · schema 1.2.0 · run business-lens-2026-11-02 · as of 2026-11-02