FINANCIAL ACCOUNTING I

Income statement
 Income statement

Usefulness
 Evaluate past performance.

 Predict future performance.

 Help assess the risk or uncertainty of

achieving future cash flows.

LO 1
 Income steatement

Elements of the Income Statement

INCOME includes both revenues and gains.
 Revenues - ordinary activities of a company
 Gains - may or may not arise from ordinary activities.

Revenue Accounts Gain Accounts

 Sales revenue
 Fee revenue
 Interest revenue
 Dividend revenue
 Rent revenue
 Gains on the sale of long-term
assets
 Unrealized gains on trading
securities.

LO 2
 Income statement

Elements of the Income Statement

EXPENSES include both expenses and losses.
 Expenses - ordinary activities of a company
 Losses - may or may not arise from ordinary activities.

Expense Accounts Loss Accounts

 Cost of goods sold
 Depreciation expense
 Interest expense
 Rent expense
 Salary expense
 Losses on the sale of long-
term assets
 Unrealized losses on trading
securities.

LO 2
 End-of-Period Adjustments

Net Income (Earnings, Profit)

Revenue - Expenses = Net

Inccoom
me
When balance sheet
is prepared
the balance of income
Equity
is transferred to equity
 Income statment

The business
cycle Sell with a margin

Collect your cash

P
urchase your stock
on credit
 Income statement

Key terms

Sales/Revenue from sales : the total amount for

which you sold products (price*quantity)
Cost of goods sold : Net purchases – Change in
inventory
Gross margin – the difference between Sales
revenues and cost of goods sold
Selling and general expenses – all expenses other
than COGS (incl. packaging, salaries)
 Income statement

Sales or Revenue
Companies generally Cost of Goods Sold
present some or all of
Gross Profit
these sections and totals
Selling and general Expenses
within the income
Depreciation
statement.
Other Income and Expense
*Also called Income from Operations (EBIT)*
operational profit Financial revenues
Financial costs
Income before Income Tax
Income Tax
Net Income
Earnings Per Share
 Income statement

Example
Net income (Profit/Loss) = Revenues - Expenses
Income statment  2018
Revenue from sales 3,053,081
- Cost of goods sold 1,982,541
= Gross margin 1,070,540
- Selling and general expenses 803,800 
- Depreciation expense 43,000
= Income from operations 223,740 
- Interest expense 50,000 
= Income before income tax 173,740 
- Income tax @20%  34,740
= Profit/Loss after tax (Net income) 138,992

Earnings per share (100,000 shares) 1.39 

 Income statement

Making a profit in wholesale

Gross Margin = Revenue from sales – Cost of goods sold

Gross Margin Ratio = (Revenue – COGS)/Sales

• The ratio tells you how much gross profit your company earns out of every dollar
sold.
• High gross margin ratio means high profits.
• But you can only get a high margin if you add value for your customers (e.g.
packaging, logistics, advertising).
 Income statement

What drives the gross

margin?
COGS = Revenue =
Price * Quantity Price * Quantity

Prices are usually You have low control

driven by the market, on prices but you can
you can’t control them. control what you sell
and how.
 Income statement

Limits to your sales (Coffe wholesaler

example)
Greater sales mean that you can make more profit.

If your gross margin is 10%:

You purchase coffee worth $15,000
you can sell it for $16,500 = $15,000*(100% + 10%)
You purchase coffee worth $20,000
you can sell it for $22,000 = $20,000*(100% + 10%)

Your profit increases from $1,500 to $2,000!

In order to increase your sales you need

warehouses, equipment (PPE): without investment,
sales won’t grow.
 Income statement

PPE Turnover

PPE Turnover = Sales / PPE

• This is a financial ratio that shows you how much

of PPE you need for every dollar of sales
• With a low number, you make low sales. With a
high number, you make large sales.
 Income statement

Getting the money

1) Purchase inventory
2) Sell to clients on credit (Accounts receivable)
3) Collect cash from clients
4) Pay your suppliers
 Income statement

An attractive accounts receivable policy

You decide whether to
grant credit to clients for:
½ month, 1 month or 2
months
You can get more of
your stock sold if you
grant better credit terms

Better credit terms

mean you collect less cash
 Income statement

Accounts receivable
turnover
Accounts receivable = Revenue from sales
turnover Accounts receivable balance

Accounts receivable turnover in days =

360 days / Accounts receivabel
turnover

If your accounts receivable policy is to award 2 months credit

to customers, you can expect the last two months of sales
to remain uncollected by the end of the year.
 Income statement

Marketing Strategy

Marketing More gross

expenses margin
 Income statement

Marketing expenses
Marketing expense ratio = Marketing expenses / COGS

The ratio tells you how much value you add to your inventory
by engaging in marketing activities useful for your clients.

If you look at an income statement of a real company,

you won’t be able to tell marketing expenses apart from other
ones, so it’s best to take all of expenses other than COGS
and depreciation.

A high ratio would mean that a company adds a lot of

value and it would typically gain a high gross margin.
 Income statement

Transfers when closing accounts

Expenses
Revenue
total = yyy Transfer total = xxx
Transfer
yyy
xxx

Profit/Loss
yyy xxx

Transfer the balance = xxx – yyy

to Retained Earnings
 Income statement

Dividends
• After the income statment and balance sheet is produced the firm may
decide to pay or not pay dividends.

• Dividends reduce retained earnings and cash.