lecture recording on 11 March 2025 at 13.15.04 PM

Overview of Revenue and Cost of Goods Sold

• Revenue refers to the money generated from sales.

• Cost of goods sold (COGS) describes the direct costs of producing the goods sold by a company.

Recognizing COGS

• When to recognize COGS:

  • Recognized when the inventory is sold, not when purchased.

  • Example: Selling a book for $10 at Barnes and Noble recognizes COGS upon the sale.

Importance of Gross Profit

• Definition of Gross Profit:

  • Gross profit is calculated as revenue minus COGS.

• Usefulness:

  • It helps businesses understand how much money is made after direct costs.

  • Particularly useful for companies selling products, less so for service-oriented businesses.

Variance in COGS Based on Business Type

• Service-Oriented Companies:

  • Businesses like banks primarily earn from service fees and interest, making COGS less impactful on overall expenses.

  • Major expenses come from salaries, which are not included in COGS.

Operating Expenses

• Definition:

  • Operational costs necessary for running the business but not directly linked to production of specific goods.

• Examples:

  • Day-to-day expenses like utilities or rent that don't fluctuate with sales volume.

  • In a bakery, selling one more muffin increases COGS due to more flour used but doesn't necessarily increase utility bills.

Income from Operations

• Calculation:

  • Income from operations is determined by subtracting operating expenses from gross profit.

• Human Capital Focused Businesses:

  • For banks, the operating expenses might be significantly higher due to personnel costs.

Non-Operating Activities

• Definition:

  • Revenues and expenses that are not part of the core business operations.

• Examples:

  • Interest revenue, casualty losses, or losses from strikes.

  • These non-operating items are reported below the income from operations.

Understanding Profit Margins

• Gross Profit Margin:

  • Calculated as gross profit divided by net sales.

• Profit Margin:

  • Calculated as net income divided by net sales.

  • Indicates the percentage of revenue remaining after all expenses are accounted for.

• Factors Affecting Profit Margins:

  • Overhead costs, industry differentiation, taxes, and non-operating items.

Industry Variations in Margins

• Competitive Industries:

  • Grocery stores often have low gross profits due to high competition and low markups.

• Product Differentiation:

  • Companies with differentiated products can command higher prices.

  • Example: Higher prices for unique tech products versus generic items.

Case Studies: Companies and Their Margins

• Gross Margin Analysis:

  • Different profiles of companies reveal varying gross margins based on their sales structure and industry.

  • Example Companies:

    • Best Buy: Gross margin of 24%, emphasizes the competitive nature of selling electronics with limited differentiation.

    • McDonald's: Higher gross margin (41%) indicating a blend of selling fast food with involved customer service.

    • Coca-Cola: High gross margin (61%) due to their model of selling syrup rights to bottlers.

• Bank Example:

  • Morgan Stanley shows a gross margin of 91%, indicating a service-oriented structure rather than product sales.

Inventory Management and Accounting

• Definition of Inventory:

  • Represents tangible items a company sells.

• Factors Affecting Inventory:

  • Purchases, manufacturing costs, shipping, and returns can all increase or decrease inventory levels.

• T-Account for Inventory:

  • Inventory is classified as an asset account, increasing with debits and decreasing with credits.