14.5 The Income Statement - Introduction to Business

Overview

• Income Statement: Summarizes a firm's revenues and expenses, showing total profit or loss over a period.
• Purpose: Used to report a firm's profitability.
• Preparation Frequency: Monthly for management, quarterly and annually for investors and creditors.

Key Components

1. Revenues

   • Definition: Dollar amount of sales plus other income (e.g., interest, dividends, rents).
   • Calculation: Start with gross sales (total sales dollar amount), subtract sales discounts, and returns and allowances.
   • Example: Delicious Desserts' gross sales were reduced by $4,500, leading to net sales of $270,500.

2. Expenses

   • Purpose: Costs of generating revenues.
   • Types:
     • Cost of Goods Sold (COGS): Total expense of buying/producing goods/services.
     • Operating Expenses: Expenses not directly related to production or purchase.

   Detailed Breakdown

   • Cost of Goods Sold (COGS)
     • For Manufacturers: Includes raw materials, labor, factory overhead.
     • For Wholesalers/Retailers: Cost of goods bought for resale.
     • Calculation:
       • Beginning inventory + Cost of goods manufactured - Ending inventory.
   • Operating Expenses
     • Selling Expenses: Related to marketing/distributing products (e.g., salaries, advertising).
     • General and Administrative Expenses: Not linked to COGS or sales (e.g., salaries of top managers, office expenses).
   • Example: Delicious Desserts had total operating expenses of $115,100.

Net Profit or Loss

• Net Profit/Income: Calculated by subtracting all expenses from revenues.
  • Steps:
    1. Deduct COGS from net sales to get gross profit.
    2. Subtract total operating expenses from gross profit to get net profit before taxes.
    3. Deduct income taxes to get net profit.
• Example: Delicious Desserts earned a net profit of $32,175 in 2018.

Important Notes

• Profit vs. Cash Flow: Profit does not represent actual cash. The income statement summarizes operating results, not cash flow.

Concept Check

1. Income Statement vs. Balance Sheet
   • Income Statement: Shows profitability over a period.
   • Balance Sheet: Shows financial position at a certain point in time.
2. Key Parts of Income Statement
   • Distinction between gross and net sales.
3. Net Profit/Loss Calculation
   • Based on revenues minus expenses.