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specific period (normally one year). It shows theprofit or loss made by the
business which is the difference between the firm's total income and its total
costs.
The income statement serves several important purposes:
Allows shareholders/owners to see how the business has performed and whether it has
made an acceptable profit (return)
Helps identify whether the profit earned by the business is sustainable ("profit quality")
Enables comparison with other similar businesses (e.g. competitors) and the industry as
a whole
Allows providers of finance to see whether the business is able to generate sufficient
profits to remain viable (in conjunction with the cash flow statement)
Allows the directors of a company to satisfy their legal requirements to report on the
financial record of the business
Explanation
Revenue
The revenues (sales) during the period are recorded here. Sometimes
referred to as the "top line" revenue shows the total value of sales made
to customers
Cost of sales
Gross profit
The difference between revenue and cost of sales. A simple but very useful
measure of how much profit is generated from every 1 of revenue before
overheads and other expenses are taken into account. Is used to calculate
the gross profit margin (%)
Distribution &
administration
expenses
Operating costs and expenses that are not directly related to producing the
goods or services are recorded here. These would include distribution costs
(e.g. marketing, transport) and the wide range of administrative expenses
or overheads that a business incurs.
Operating profit
A key measure of profit. Operating profit records how much profit has
been made in total from the trading activities of the businessbefore any
account is taken of how the business is financed.
Finance expenses
Interest paid on bank and other borrowings, less interest income received
on cash balances, is shown here. A useful figure for shareholders to assess
how much profit is being used up by the funding structure of the business.
Tax
Profit attributable
to shareholders
The amount of profit that is left after the tax has been accounted for. The
shareholders then decide how much of this is paid out to them in dividends
and how much is left in the business ("retained earnings" in the equity
Net Sales
Net sales are the overall sales for the accounting period minus the allowances for the trade discounts and
returns. The permitted amount for returns differs depending on the type of business. Net sales can also be
described as the amount of money derived from sold goods or rendered services. The equation for the net sales
is,
Net Sales = Gross Sales (Return and Allowances)
Cost of Goods Sold ($) = Total Sales ($) Gross Profit ($), where
Gross Profit ($) = Total Sales x Gross Margin (%)
The technique in accumulating the cost of goods sold for manufacturers is different compared to the method
used by retailers and wholesalers. Manufacturers include the direct labor, indirect labor, factory overhead, and
materials and supply.
Income Taxes
Income taxes are an inevitable part of any business transaction and can be taxed by the local, state, and/or
federal government. Income taxes can be calculated by using published tax tables.
Net Income
Also termed as net profit or earnings, net income is the last item on the financial statement. It shows the gained
base profit by an entity during the specified accounting period.
By using different valuation methods permitted in accounting, various profit results will be obtained. For
instance, FIFO and LIFO will each yield disparate profit outcomes.
Some values recorded on the income statement are based on judgments and appraisals. An example is the
depreciation expenses which is established on approximation of its useful life and salvage value.
The income statement cannot specify the owners assets and liabilities, and the Accounts Receivable and
Payable.
2. Current assets: Current assets are any assets that can be easily
converted into cash within one calendar year. Examples of
current assets would be checking or money market accounts,
accounts receivable, and notes receivable that are due within
one year's time.
Cash
Money available immediately, such as in checking accounts,
is the most liquid of all short-term assets.
Accounts receivables
This is money owed to the business for purchases made by
customers, suppliers, and other vendors.
Notes receivables
Notes receivables that are due within one year are current
assets. Notes that cannot be collected on within one year
should be considered long-term assets.
to
those
assets
at
an
instant
in
time.
can
split
the
BS
in
two
mayor
blocks:
Assets
and
Liabilities/Funds:
Assets
Liabilities/Funds
Things owned
by
the business
$1000
Amounts owed
by
the business
$1000
Assets ($1000)
The
Total
Balance
Liabilities/Funds
Sheet
($1000)
Structure:
Liabilities/Funds
CA
This
block
includes
Liabilities/Funds
FA
CA
company
or
its
assets.
Total
Owner
Assets = Total
Funds
(OF)
Liabilities therefore
Owner
Funds
Liabilities/Funds
FA
CA
CL
(OF)
Liabilities/Funds
FA
CA
LTL
CL
and
5.
All
long
debt
Owner
claims
Assets
by
(from
to
Funds
the
owners
of
Liabilities/Funds
20
years).
(OF)
the
business:
FA
CA
OF
LTL
CL
Issued common stock:nominal value or book value is
the price used to bring owners of capital into the business.
It differs from the market valuewhich fluctuates.
Capital reserves: By the law in some countries is a
statutory
reserve.
This
account
covers
all
surpluses
performance
of
Assets
a
Liabilities/Funds
1.Fixed Assets
$700
2.Current Assets
$300
company.
5.Owners Funds
$450
4.Long Term L
$350
3.Current Liabilities
$200
1.
Total
Assets =
$700
FA)+
300
(CA)
$200
(CL)
or
Total
Assets =
$450(
FA)+
$350(CA)
terms
loans.
Funds
Long
Term
liabilities
funds
3.
of
long
the
term
company.
Net
worth:
Net worth = $700 (FA) + $300 (CA) $200 (CL) $350 (LTL)
The value of the company isdeterminate by the value ofthe tota
l assets lessexternal liabilities. In otherwords, once acompany
pays all debts theremaining belongs to theowners of the compa
ny.
4. Working
capital
(WC)
rich
in
assets,
but
short
in
liquidity.
Current Liabilities ,
WC =
$200
and
the
fixed
assets.
WC = OF + LTL FA,
$350
WC = $450 +
-
$700
WC = $750 -
$700
Which means that those long terms funds that are not linked to
fixed assets determine the working capital.