Financial Analysis LAP 4
Performance Indicator FI:094
(Income Statements)
Objectives:
Describe the components
of an income statement.
Explain how the income
statement is utilized by
businesses.
Financial Analysis LAP 4
Describe the components of
an income statement.
Viewing
a business’s
financial
•Typical
Some
The
income
financial
statement
statements
is the
give
feature
“previews.”
Saturday night at the
local
cinema
statements
is a lot like this.
presentation.
• Gives
the for
entire
picture
• You’re
ready
thefinancial
main attraction.
• Summarizes where the business’s money
• But wait—the previews come first!
came from and where it went
• They provide a “sneak peek,” but not an overall
view of a movie.
Income Statements
A
Lists
summary
all revenues
of a business’s
and expenses
income
for aand
certain
expenses
time period,
over a usually
period of
one
time
year
Example
Income Statement Aliases
Earnings statement
•A
business’s
havingleft
income
Profit
is the income
over doesn’t
once all
necessarily
mean
expenses are
paid.that it is earning a profit.
• The income
statement is the
only financial
statement that
enables the
business to look
at its net profit.
Income Statement Aliases
Operating statement
• Its information is used by businesses to make a
variety of decisions that affect how the business
will operate.
• How to invest
money
• Ways to cut back
on expenses
Income Statement Aliases
Operating statement
• The statement is also used to create other
financial documents that direct how the
business will operate:
• The cash-flow
statement
• The balance
sheet
Income Statement Aliases
Profit-and-loss statement
• Traditional
Basic calculation
used
analyze
an income
term for
the to
income
statement
statement is “income minus expenses.”
• Over
• Explains what it accomplishes
very time,
well however,
income statement
• If the outcome is negative,
positive,
has become the
the business has a profit.
loss.
common business
term for this
important summary.
Income Statement Categories
Five Main Categories
on an Income Statement
Revenue
Cost of goods sold/Cost of sales
Gross profit
Operating expenses
Net income/profit
The total amount of money
earned by a business
Includes:
•
•
•
•
Sales of the business’s goods and services
All money
Interest
earned
bank
accounts
coming
in from
to the
business,
no matter
what the source,
Returns
on investments
is revenue.
Sale of the business’s assets
Cost of Goods Sold / Cost of Sales
Includes all direct costs to obtain and/or produce the
goods or services that a business sells, such as:
• Raw materials
• Manufacturing overhead
• Packaging
• Shipping
• Labor
• Supplies
• Unsold items
• Stolen items
• Returned items
Cost of Goods Sold / Cost of Sales
Different businesses have different kinds of costs.
• Retailers
have costs
with obtaining
Manufacturers
haveassociated
costs associated
with goods
from
others
and reselling them
to ultimate
users, and
making
a product—“cost
of goods
sold.”
service providers are concerned with all costs directly
associated with providing their services—“cost of sales.”
Determining
thesubtracting
gross profit
helps
 In
this way, businesses
are the
able
to businesses
see
Determined
by
cost
of goods

to
see
much
money
invested
what
ishow
costing
the
most they’ve
money and
can in
sold
from
revenue
making
or obtaining
their products
versus
target trouble
areas more
effectively.
The
profit
made
other remaining
how total
much
it costs
to before
run theall
business.
expenses have been deducted
Addresses all other expenses associated
with the business, including:
•
•
•
•
Employee
Mortgage or
wages/salaries
rent
Advertising
Administrative costs
Insurance
Interest paid on outstanding
loans
Utilities
The business
expenses pays
incurred
these
from
expenses
keepingsoa it
May
be
either:
business’s
can
operate.
doors open.
•
Variable—amounts that are
constantly changing, such as
advertising costs
•
Fixed—amounts that stay the
same for long periods of time,
such as rent
—
Business’s final profit
Money the company actually makes after
all expenses have been deducted
and taxes paid
Usually considered most
important item on income
statement
Answers the question,
“Is this business profitable?”
—
Sometimes called net profit or net earnings
Accuracy of this “bottom line”
depends on accuracy of reported
revenues and expenses.
• Income statements determine final
profit and are also used to develop
other financial documents. They must
be as accurate as possible.
• Life of the business can depend on it.
The Whole Picture
 Income statements show a business’s total financial
picture—the good, the bad, and the ugly.
 This picture is cumulative.
 Each income statement represents
a total for a specific time period—
usually one year.
The Whole Picture
 Income statements can be produced for quarters
or months if desired.
 A business must be able to see cumulative totals
so that it can see where it is successful and where
there might be trouble brewing.
 To ensure that the total for each
category is correct, a business will
often develop a more complex income statement with an extensive
breakdown under each category.
Explain how the income statement
is utilized by businesses.
Financial Ratios
When developing the income statement, a business
must first gather information from each department
or division that relates to:
• Revenue
• Cost of goods sold/Cost of sales
• Operating expenses
This information is then
compiled, totaled, and used
to calculate gross profit and
net profit.
Financial Ratios
• A this
ratioisiscompleted,
created when
numberwill
is divided
Once
theone
business
transform
into another—it
shows
the relationship
the final
numbers into
financial
ratios.
between the numbers.
• Ratios can be compared:
• By category
• Over time
• To the competition
• Over 100 different ratios can
be created from a business’s
financial statements.
 By
Businesses
themselves,
need
elements
to be able
of to
an see
income
how statement
categoriesare
are
simply categories
affecting
each other
and
and
totals.
the bottom line.
• Is the business spending too much on operating expenses?
• Are sales keeping up with expenses?
• Is the business earning more profit than it is spending for
the cost of goods sold?
 The answers to these questions are
critical for the business’s stability
and financial success.
Comparing Categories Over Time
• What if a business wants to know how much it spent
on expenses last year compared to this year?
Monitoring
Businesses
sales
notgrowth
only need
is critical
to
• Or, what iffor
it wants to know if profit has been improving
know
the business’s
their financial
success.
over the last five years?
circumstance for one year, but
also over time.
• To determine this, a business needs to be able to compare
numbers from income statements from different years.
Competitive Analysis
Byimproving
comparing
from its
• Is the business
or numbers
deteriorating?
A
competitive
Even when
aanalysis
business
is
income
statement
withhelps
those
a earning
business
to
see
itsbusiness
strengths
• Is it generating
enough
to obtain
an
acceptable
profit?
asales
profit,
still
needs
of
its
competitors,
ait
will
and
weaknesses
relation
toifknow
how it isindoing
by
know
it is operating
as
profitably
• How effectivelytoisthose
the business
managing operating expenses?
of
the
competition.
industry
standards.
as it should be.
• Is the business producing a product for more or less cost than
its competitors?
Who Analyzes Income Statements?
Top executives and managers
• Look at ratios to monitor
operations and determine
whether their company is
running efficiently
• Also use the income
statement to monitor
yearly profit
Who Analyzes Income Statements?
Creditors
• Utilize information generated from the income statement
to review the financial
status of a business
• Responsible for deciding
if a business is granted
a loan or a cash advance
• The income statement
helps creditors assess
the business’s creditworthiness and the risk
of extending credit.
Who Analyzes Income Statements?
Investors and potential investors
•
•
•
Have part ownership of a business
The value of the stock depends on:
Use
income
• How
muchstatement
profit the
to monitor
profit
business
has levels
been able
to make over time
• The potential of the
business to continue
making a profit
Who Analyzes Income Statements?
Investors and potential investors
• Ratios calculated from the income statement:
• Allow investors to
monitor how much
profit the business
is making
• Assure them that
they are getting a
good return on their
investment
• Income statements don’t have to be just for businesses.
• You can make a personal income statement for yourself!
• Over the next month, keep track of all the money you
bring in:
•
•
•
•
From your allowance
From babysitting
From mowing lawns
From gifts or birthday money
you receive
• What’s
Also, keep
yourtrack
totalof
atall
thethe
end
money
of theyou
month?
spend:
• Onmaking
lunch a profit or suffering a loss?
• Are you
• On movies or video games
• How •can
information
help you as you
On this
library
fines
budget in the future?
• On gifts for family or friends
 Sometimes,
the
is unhappy
the story
The accuracy
ofbusiness
a business’s
incomewith
statement
is a
those
tell.
matterfigures
of great
importance.
• A non-profit organization may not want to show an
 A number
business
and
decisions
excessof
of income
at the
endinvestment
of the year because
it
are made
based ondonors
the figures
thatmoney.
appear on the
might discourage
from giving
document.
• Donors might not think it’s necessary to give if the
organization seems to have plenty of resources.
 Sometimes, the business is unhappy with the
story those figures tell.
• To solve this problem, the organization may tuck some
of the extra income away in a column on the income
statement labeled something such as “reserve funding.”
• That way, the organization doesn’t appear to have as
much excess income at the end of the year.
 The organization isn’t really hiding the income—
it’s right there on the income statement,
but not in the final figure at the bottom.
 What do you think?
 Is this an ethical practice?
Acknowledgments
Original Developers:
Lelia Ventling and Sarah Bartlett Borich
MarkED
Version 1.0
MarkED Resource Center
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