Download Multi-Step Income Statement

Income Statement Review
Dr. Craig Ruff
Department of Finance
J. Mack Robinson College of Business
Georgia State University
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© 2014 Craig Ruff
The Basic Income Statement…
Revenue
minus
Expenses
Income
•The income statement is the accounting statement that matches a
company’s revenues with its expenses over a period (typically, a quarter
or a year).
•It is a flow measure… the cumulative amount over the period. This is
in contrast to a stock measure, which looks at things at a given point in
time.
•Profit does not equal cash flow. Accounting is accrual based. Sales are
recorded when made and expenses are recorded when incurred, even if
the cash flows from these transactions occur in different periods.
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2013
Net Sales
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses
Operating Profit (Operating Income, Earnings Before Interest and Taxes, EBIT)
minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT)
minus Taxes
Net Income (Earnings)
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© 2014 Craig Ruff
Multi-Step Income Statement –
Slightly Different Version
Income Statement
XYZ Company
For the Year Ending December 31, 2013
This is the same as the
statement on the previous
slide; however, on this one,
depreciation expense is
broken out from the
operating expenses.
Net Sales
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses (excluding Depreciation Expense)
minus Depreciation Expense
Operating Profit (Operating Income, Earnings Before Interest and Taxes, EBIT)
minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT)
minus Taxes
Net Income (Earnings)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2013
Net Sales
Net Sales = Gross Sales – (Returns and Allowances).
The term ‘top line’ refers to a company's gross sales (or revenues). So, for
instance, when you hear the term, ‘top-line growth’, this is a reference to an
increase in the company’s gross sales (or revenues).
Sales Returns happen when a customer returns defective, damaged, or
otherwise unwanted products to the seller. Sales allowances happen when a
customer agrees to keep damaged, defective or unwanted merchandise in
exchange for a reduction in the selling price.
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2013
Net Sales
minus Cost of Goods Sold
These are the direct costs associated with the manufacture or sale of
the product.
For a retail company, the COGS is simply the cost of materials
purchased for resale.
For a manufacturing company, the COGS can also include labor costs,
manufacturing overhead, and depreciation expenses associated with
production.
Unless stated otherwise, we will assume that all firms are retailers
and, thus, COGS will simply be the cost of materials purchased for
resale.
© 2014 Craig Ruff
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Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2013
Net Sales
minus Cost of Goods Sold
Gross Profit
The gross profit and the gross profit margin (gross profit/sales) are very
important numbers in finance.
For instance, the gross profit margin provides an indication of how
effectively a manufacturing company is managing its production process
and its use of outside suppliers.
Another interpretation is that the gross profit margin shows the
percentage of sales (or revenues) available to cover operating expenses.
Additionally, the gross profit margin can often tell you something about a
company’s business strategy.
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2013
The operating expenses are the business-related expenses
other than cost of goods sold that a company incurs in the
normal course of its business.
These include advertising expenses, repairs and
maintenance costs, research and development costs (R&D),
sales, general and administrative costs (SG&A), and
Net Sales
management salaries. For manufactures, depreciation can
be in the COGS; for retailers, depreciation is in the operating
minus Cost of Goods Sold
expenses.
Gross Profit
minus Operating Expenses (excluding Depreciation Expense)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Depreciation is the accounting process
by which a company allocates an
asset's cost over its expected useful
life.
Income Statement
XYZ Company
For the Year Ending December 31, 2013
Net Sales
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses (excluding Depreciation Expense)
minus Depreciation Expense
© 2014 Craig Ruff
Imagine that a company buys a piece
of equipment for $1,000,000. Also,
assume that the equipment is
expected to last for 10 years and have
zero salvage value. It would not
present an accurate picture to expense
the entire $1,000,000 in the year that
equipment is purchased. Instead the
accountants will spread out the cost of
the machine by gradually expensing
the $1,000,000 over the course of the
expected 10-year life of the asset.
Again, for manufactures, depreciation
can be in the COGS; for retailers,
depreciation is in the operating
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expenses.
Multi-Step Income Statement…
Like gross profit and the gross profit margin, operating
profit and the operating profit margin (operating
profits/sales) are important finance variables.
Income Statement
XYZ Company
For the Year Ending December 31, 2013
They serves as an indication of how effectively a company
is managing its core business and shows the percentage
of sales (or revenues) available to cover interest and
payback borrowing.
Net Sales
minus Cost of Goods Sold
Note that operating profit has a variety of names. I tend
to use EBIT, because that reminds us what comes next.
Gross Profit
minus Operating Expenses (excluding Depreciation Expense)
minus Depreciation Expense
Operating Profit (also called: Operating Income, Earnings Before Interest and
Taxes, EBIT)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2013
Interest expense captures the interest
cost of the company’s debt in that period.
Net Sales
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses (excluding Depreciation Expense)
minus Depreciation Expense
Operating Profit (Operating Income, Earnings Before Interest and Taxes, EBIT)
minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2013
Taxes reflect income taxes at all levels.
(Remember that what the company is
actually paying in taxes in a given period
is not the same as what the company
truly owes…the difference going into
deferred taxes.)
Net Sales
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses (excluding Depreciation Expense)
minus Depreciation Expense
Operating Profit (Operating Income, Earnings Before Interest and Taxes, EBIT)
Minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT)
minus Taxes
Net Income (Earnings)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2013
Net Sales
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses (excluding Depreciation Expense)
minus Depreciation Expense
Operating Profit (Operating Income, Earnings Before Interest and Taxes, EBIT)
Minus Interest Expense
Net income is often referred to as the
‘bottom line.’ It is a standard measure of
Profit Before Taxes (Earnings Before Taxes, EBT)
the company’s profitability.
minus Taxes
Net Income (Earnings)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2013
Net Sales
minus Cost of Goods Sold
Gross Profit (1)
minus Operating Expenses (excluding Depreciation Expense)
minus Depreciation Expense
Operating Profit (Operating Income, Earnings Before Interest and Taxes, EBIT) (2)
Minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT) (3)
minus Taxes
Net Income (Earnings) (4)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2009
Net Sales
Assets
Liabilities
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses
Operating Profit (Operating Income, Earnings Before
Interest and Taxes, EBIT)
Equity
minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT)
minus Taxes
Net Income (Earnings)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2009
Net Sales
Assets
Liabilities
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses
Operating Profit (Operating Income, Earnings Before
Interest and Taxes, EBIT)
Equity
Minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT)
minus Taxes
Net Income (Earnings)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2009
Net Sales
Assets
Liabilities
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses
Operating Profit (Operating Income, Earnings Before
Interest and Taxes, EBIT)
Equity
Minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT)
minus Taxes
Government
Net Income (Earnings)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2009
Net Sales
Assets
Liabilities
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses
Operating Profit (Operating Income, Earnings Before
Interest and Taxes, EBIT)
Equity
Minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT)
minus Taxes
Net Income (Earnings)
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© 2014 Craig Ruff
Multi-Step Income Statement…
Income Statement
XYZ Company
For the Year Ending December 31, 2009
Net Sales
minus Cost of Goods Sold
Gross Profit
minus Operating Expenses
Operating Profit (Operating Income, Earnings Before
Income and Taxes, EBIT)
Minus Interest Expense
Profit Before Taxes (Earnings Before Taxes, EBT)
minus Taxes
Net income can ‘go to’ two places:
(1) It is paid out as dividends to
shareholders.
(2) It is added to (or subtracted from)
retained earnings.
Net Income (Earnings)
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© 2014 Craig Ruff
Multi-Step Income Statement…
…paid out as dividends to firm’s
shareholders, or
Net Income
is either…
…added to (or subtracted from) retained
earnings. You can think about this as
the money is being ‘reinvested’ in the
firm, kept as ‘cash’, used to reduce
existing debt, etc. Point: there is no
retained earnings bank account.
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© 2014 Craig Ruff
End
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