Discussion post
Summary Notes: A3—Income Statement and Statement of Retained Earnings
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Income statement records information on: Revenue--income from goods and services sold Expenses—spending undertaken by the firm to generate revenue The income statement tells us if the company made a profit or loss over a particular time frame (month, quarter, or year). Net Income Equation:
Revenue – Expenses = Net Income
Income statement (figures are in thousands): J&M, INC. INCOME STATEMENT for Year Ending December 31, 2015)
Total revenue $300,000
Cost of revenue Gross profit
188,000 112,000
Operating expenses Selling/admin Depreciation Lease expense Total
44,720 20,000 14,000 78,720
(78,720)
Operating income Interest pmt. Income before income taxes Provision for income taxes Net income
33,280 (5,200) 28,080 (8,080) $20,000
Notes on income statement:
• Revenue from goods and services sold in accounting period • Cost of revenue—wages, cost of raw materials etc. • Gross profit (gross margin) = revenue - cost of revenue as percent of revenue
o ($112,000,000/$300,000,000) x 100 = 37.33% • Operating expenses (interest, rent, payroll, selling, administration etc.)
o Unlike cost of revenue, operating expenses are incurred even if no goods are sold o Depreciation (allowance for aging of an owned asset) is an operating expense because it
is part of normal business operations • Operating margin = gross profit – operating expenses as percent of revenue
o $33,280,000/$300,000,000) x 100 = 11.09% • Interest pmt.—interest paid on bonds, lines of credit etc.
• Net income = net profit = accounting income = net margin = “the bottom line”
Summary Notes: A3—Income Statement and Statement of Retained Earnings
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o Net margin = net income as a percent of revenue § ($20,000,000/$300,000,000) x 100 = 6.67%
Why do we bother to calculate 3 different definitions of profit for the firm?
• If firm is having trouble with its profitability, doing so can help identify the source(s) of problem(s)
o Too few sales and too high cost of goods? That will show up in gross margin o Too much spent on advertising or other costs? That will show up in operating margin o Can’t have a healthy bottom line unless the other margins are healthy o Stock analysts often compare these margins to other firms in the industry which,
presumably, operate under similar conditions--red flag if costs seem excessive. Companies report retained earnings to show how net profit was deployed Example: Statement of retained earnings for J&M, Inc. 2015 (figures are in thousands)
Cash Dividends
Preferred stock $600
Common stock 9,400
Total dividends $10,000
Retained earnings
Beginning of year (01/01/2015) $32,400
Current year 10,000
End of Year $42,400
Notes: • Recall from the income statement that J&M, Inc. had net income of $20,000,000 this year • Paid out dividends totaling $10,000,000 to both preferred and common stock holders • Retained $10,000,000 to reinvest in the business • The balance sheet (Summary Notes A2) shows retained earnings for 2015 were $42,400,000, up
$10,000,000 from 2014 when they were $32,400,000. • Companies that are growing rapidly often don’t pay dividends and plough any profits back into
the company to support future growth: o Shareholders in growth companies interested in growth of the stock price, not dividend
• Companies that offer a mature product in a mature market (like electrical utilities) pay dividends Earnings per share (EPS)
• How many fellow shareholders do you have to split the pie with? • Example: Balance sheet shows 10 million shares outstanding (Summary Notes A2):
EPS = $20,000,000 = $2
10,000,000