Income Statements Flashcards

Income Statements

Final Accounts

• Final accounts are published accounts of an organization, accessible to various stakeholders like managers, employees, shareholders, sponsors, financiers, and investors.

• These differ from management accounting, which is for internal and confidential use.

• Final accounts include:

  • Profit and Loss Account (Income Statement)

  • Balance Sheet

Profit Calculation

• Profit is an objective for most businesses.

• Profit is calculated as: profit = revenue - cost _of_making_the_products

• Profit is the surplus remaining after subtracting business costs.

• A loss occurs if costs exceed revenue.

• Profit can be increased by:

  1. Increasing revenue by more than the costs.

  2. Reducing the cost of making products.

  3. A combination of both.

Profit vs. Cash

• Profit and cash are not the same.

• A business can show a profit on paper but have little to no cash in the bank.

  • This can happen if sales are made on credit but the cash hasn't been received yet.

• Timing of cash flows:

  • Money from profitable sales may arrive months later.

  • This time lag can cause cash flow problems, even for profitable businesses.

• Causes of cash shortfalls:

  • Over-trading: Expanding too rapidly and tying up funds in inventory or new assets.

  • Credit Policies: Allowing customers long credit periods delays incoming cash.

  • Large Asset Purchases: Buying expensive non-current assets (e.g., machinery, property) without careful planning can deplete cash reserves.

• A business can become insolvent if it cannot meet its short-term debts, even with a reported profit.

• Managing cash flow is critical.

Profit & Loss Account (Income Statement)

• The profit & loss account, also known as the income statement, summarizes revenues, costs, and expenses during a specific period (usually a quarter or year).

Key Components of an Income Statement

• Sales Revenue (Sales Turnover): The money an organization earns from selling goods and services.

• Costs of Goods Sold (COGS): Direct costs of production (raw materials, component parts, direct labor).

• Gross Profit: The difference between revenue and costs of goods sold (COGS).

  • Gross_profit = revenue - costs_of_goods_sold (COGS)

• Gross profit is calculated before fixed costs are considered.

• Expenses: Indirect costs of production (rent, management salaries, marketing campaigns, travel expenses, repairs and maintenance, insurance, and depreciation).

• Net Profit Before Interest & Tax: Shows profit (or loss) before deducting interest payments on loans and taxes on corporate profits.

• Tax: Compulsory deduction paid to the government as a proportion of a business’s profit.

• Net Profit After Interest & Tax: Shows the actual profit earned after all costs are accounted for.

  • Belongs to the owners of the business.

  • Can be distributed to shareholders/owners and/or kept in the business as retained profit (internal finance).

• Dividends: Payments from a business’s net profit after interest and tax paid to the shareholders (owners) of the business.

• Retained Profit: Funds left over from net profits (after interest and tax) that are not paid to shareholders and kept within the business for its own use.

  • A vital internal source of finance.

Profit and Loss Account Structure

• Sales Turnover

• (-) Cost of Goods Sold (COGS)

• Gross Profit

• (-) Expenses

• (-) Depreciation

• Net Profit Before Interest & Tax

• (-) Interest

• (-) Tax

• Net Profit After Interest & Tax

• (-) Dividends

• Retained Profit

Example: Chan’s Bike Hire Co.

• For the year ending 31 March 2021:

  • Sales revenue: 400

  • Rent: 40

  • Interest: 20

  • Cost of goods sold: 150

  • Expenses: 30

  • Tax: 25

Example: Newtown Garden Nursery Ltd.

• For year ending 31/3/2019:

  • Costs of goods sold: 37,000

  • Gross profit: 32,000

  • Wages: 5,000

  • Electricity: 4,500

  • Rent: 3,000

  • Depreciation: 3,200

  • Selling and advertising expenses: 5,000

  • Interest: 250

  • Tax: 300

Example: Samba Ltd. (in thousands)

• For the year ending 30 April 2020:

  • Sales revenue: 3450

  • Costs of goods sold: 1500

  • Rent: 60

  • Advertising: 30

  • Distribution: 60

  • Other expenses: 10

  • Tax: 10

Example: Aurelie (Sole Trader)

• For the year ending 31 March 2022:

  • Revenue: 5600

  • Costs of goods sold: 1800

  • Expenses: 2400

Example: BGR (Private Limited Company)

• BGR operates 6 cinemas and plans to open another costing 8m, using retained profit.

• Requires recruiting 10 new employees.

Example: Township plc

• For the year ending December 31, 2021:

  • Sales revenue: 110,000

  • Gross profit: 51,000

  • Marketing expenses: 10,250

  • Profit before interest and tax: 28,000

  • Interest: 1,700

  • Tax: 2,500

Example: Genesis Corporation

• At December 31, 2020:

  • Sales revenue: 275,000

  • Costs of goods sold: 170,000

  • Wages: 50,500

  • Selling expenses: 15,650

  • Bills: 10,700

  • Depreciation: 6,000

  • Rent: 7,000

  • Interest: 8,750

  • Tax: 6,000

Analysis of Genesis Corporation

• The company wants to expand internally, costing 50,000.

• The retained profit (400) is not sufficient for the internal expansion (50,000).

• Having a bank loan is crucial to achieve the expansion plan.

• The company may need to issue new shares to finance the expansion because it already has a bank loan with 8,750 interest cost, and the retained profit is low.