Income Statement and Profitability Analysis

Financial Reports

  • Balance Sheet: Reports a company's assets, liabilities, and equity.
  • Statement of Cash Flows: Depicts the movement of cash through a business.
  • Income Statement: Provides an overview of a business's revenue, expenses, and profit.

Income Statement

  • Used to:
    • Determine the operating performance of a business.
    • Determine income tax liability.
  • May be used to:
    • Assist a business in procuring financing.
    • Form operating budgets.
    • Determine if areas of a business are over or under budget.
    • Compare business operations from period to period.
    • Compare business operations from business to business.

Costs

  • Fixed Costs: Unaffected by changes in sales volume.
    • Examples: Rent, cable and music subscription, contract cleaning.
  • Variable Costs: Directly related to business volume.
    • Examples: Food, beverage.
  • Semi-Variable Costs: Have a fixed and variable component.
    • Example: OpenTable (monthly fee & per guest fee), total labor (salary and hourly).

Income Statement Format

  • Can cover any time period (e.g., 4 weeks versus monthly financial periods).
  • Common Size Income Statement: Lists dollars and percentages for each line item and category.
    • Percentages express each line item as a percentage of total sales, except for subheadings under "Cost of Sales."
  • Always starts with a "Sales" category subdivided into "food" and "beverage" sales.
    • Percents for food and beverage sales show the sales mix.
    • Total sales always equals 100%.

Vertical Analysis

  • Percentages on the Profit & Loss (P&L) statement.

Cost of Sales

  • Subcategories use different percent bases (not based on total sales).

  • Food Cost %:

    Food\ Cost \% = \frac{Food\ Cost}{Food\ Sales}

  • Beverage Cost %:

    Beverage\ Cost \% = \frac{Beverage\ Cost}{Beverage\ Sales}

  • Total Cost of Goods Sold:

    • Sum of food and beverage costs (variable).

Gross Profit

  • Money left from sales after deducting the total cost of goods sold.

Components of Income Statement

  • Labor: A semi-variable cost.
    • Salaries and Wages: Workers’ income.
    • Employee Benefits: Cost of benefits.
  • Prime Cost: Sum of total cost of goods sold and total labor cost.
  • Controllable Expenses: All other semi-variable costs.
  • Direct Operating Expenses: Costs for items other than food and drink for serving customers (e.g., flowers, china, menus, uniforms, laundry, cleaning supplies).
  • Music and Entertainment: License fees and royalties, performer fees, and food and equipment for entertainment.
  • Marketing: Costs for all marketing activities (advertising, PR, comp meals, etc.).
  • Utilities: Costs for gas, water, electric, and waste removal.
  • General and Administrative: Costs for infrastructure (telephone, internet, insurance, office supplies, etc.).
  • Repair and Maintenance: Cost for all equipment and facility repairs and maintenance.
  • Total Controllable Expenses: Sum of all controllable expenses.
  • Income before Fixed Costs:
    • Equals Total Sales – Prime Cost – Total Controllable Expenses.
    • Amount left to cover fixed costs and profit.
  • Fixed Costs:
    • Occupancy Costs: rent, property taxes, property insurance.
    • Interest: Cost of using someone else’s money (e.g., interest paid to a bank for a loan).
    • Depreciation: Accounting device to spread a significant cost across multiple years.
  • Total Fixed Costs: Sum of all fixed costs.
  • Profit before Taxes: Income before fixed costs – total fixed costs.
  • Net Profit Before Income Tax (loss): From pre-tax profit, income tax and profit are determined.

Income Statement Graphic Formula

  • \% = \frac{Cost}{Sales}
  • For food cost and beverage cost, "sales" is the corresponding food sales or beverage sales; all other items use "total sales" for sales.

Example Calculation

  • Marketing expense: 7,000.00
  • Total sales: 380,000.00
  • Marketing %: \% = \frac{$7,000.00}{$380,000.00} = 0.018421 \approx 1.84\%

Food Cost Calculation Example

  • Food sales: 114,600.00
  • Target food cost %: 30.4%
  • Food cost: Food\ Cost = Food\ Sales \times Food\ Cost\% = $114,600.00 \times 0.304 = $34,838.40

Income Statements vs. Budgets

  • Similar line item names and common size format.
  • Income statements use real data from history; budgets are forward-looking plans.
  • Often compared side-by-side.
  • Two approaches to compare: common size analysis and comparative analysis.

Common Size Analysis

  1. Calculate the difference between percent columns on each budget/income statement line item.
  2. Variance = income statement percent – budget percent (or new statement’s percent – older statement’s percent).
    • Total sales variance will always be zero (since total sales are always 100%). Look at sales dollars separately.

Variances

  • Management determines acceptable variance range in advance.
  • Management must decide what to do about unacceptable variances:
    • Controlling costs
    • Boosting revenue through marketing
    • Adjusting the budget
  • If figures beat expectations without sacrificing business standards, changing the budget may be appropriate.

Profit and Loss Statement Exercise

  • Food Sales: 100%
  • Food Cost: 349,725.00, 33%
  • Labor Cost: 29%
  • Overhead: ?
  • Profit: 7%

Solving the Exercise:

  1. What is the Food Sales Figure?

    • Food\ Sales = \frac{Food\ Cost}{Food\ Cost\%} = \frac{$349,725.00}{0.33} = $1,059,772.73

  2. What is the Labor Cost Figure?

    • Labor\ Cost = Sales Revenue \times Labor\ Cost\% = $1,059,772.73 \times 0.29 = $307,334.09

  3. What is the Overhead Cost Figure?

    • Calculate Overhead Percentage: 100% - 33% - 29% - 7% = 31%
    • Overhead\ Cost = Sales \times Overhead\% = $1,059,772.73 \times 0.31 = $328,529.55

  4. What is the Profit Figure?

    • Total Costs: 349,725 + $307,334.09 + $328,529.55 = $985,588.64
    • Profit = Sales - Total\ Costs = $1,059,772.73 - $985,588.64 = $74,184.09