<5.3 INCOME STATEMENTS>

--5.3.1 THE IMPORTANCE OF PROFIT--

--HOW IS IT MADE?--

IF SALES REVENUE > TOTAL COST = PROFITS
IF SALES REVENUE < TOTAL COST = LOSSES

--WHY IT'S IMPORTANT?--

IT IS THE REWARD FOR ENTERPRISE: An entrepreneur spends considerable amounts of time and money on developing their ideas. If their idea eventually generates profits it CAN BE VIEWED AS A COMPLIMENT TO THEIR ENTERPRISE AND A VINDICATION of their efforts and business sense.
IT IS THE REWARD FOR RISK TAKING: In addition to spending their money, ENTREPRENEURS also TAKE ON THE RISK OF FAILING AND LOSING ALL THEIR INVESTMENT, as such the PROFIT can be seen as COMPENSATION or the REWARD for all the WORRY and ANXIETY.
SOURCE OF FINANCE: After payments are made to owners, PROFITS ARE REINVESTED BACK INTO THE BUSINESS for further EXPANSION (this is called 'RETAINED EARNINGS./PROFITS')
INDICATOR OF SUCCESS: More PROFITS INDICATE TO INVESTORS that the BUSINESS IS WORTH INVESTING IN, and they will INVEST MORE, or it will be EASIER TO RAISE CAPITAL THROUGH SELLING SHARES.

--PROFIT--

PROFIT is the SURPLUS amount AFTER TOTAL COSTS have been deducted from TOTAL REVENUE.
PROFIT = TR* - TC**
- - **TOTAL COSTS include payments NOT YET PAID.
  - *TOTAL REVENUE includes income NOT YET RECEIVED.

--CASHFLOW--

CASHFLOW ONLY refers to elements paid in CASH IMMEDIATELY, so all payments and costs that have yet to paid are NOT INLCUDED.

--TASK--

Complete the table below to prove that a firm can be 'PROFITABLE' but can have a negative CASHFLOW.

--5.3.2 INCOME STATEMENTS--

--DEFINITION--

An INCOME STATEMENT is a financial document of the business that records all INCOME GENERATED by the business as well as the COSTS INCURRED by the business and thus the PROFIT or LOSS made over the financial year. Also known as PROFIT & LOSS ACCOUNT.

--TASK--

Watch the video below and construct Tom's basic income statement.

REVENUE
COGS
GROSS PROFIT
NET PROFIT

--MAIN FEATURES--

--TASK: COPY THE FOLLOWING FORMAT EXACTLY--

1) SALES REVENUE

SALES REVENUE = QUANTITY SOLD & SELLING PRICE

+$1250

2) LESS COST OF GOODS SOLD (COGS)

COST OF GOODS SOLD (COGS) = THE DIRECT COST OF PRODUCING THE GOODS ACTUALLY SOLD (NOT THOSE THAT ARE UNSOLD) in the SPECIFIC TIME PERIOD.
This includes all VARIABLE COSTS such as wages and raw material costs DIRECTLY involved in the production/sale of these units.
EXAMPLES:
- - Labor directly tied to production
  - Direct materials needed for the production of goods and services.

($900)

--TASK--

THE QUANTITY OF GOODS SOLD IN A CERTAIN TIME PERIOD IS = (TO THE AMOUNT OF OPENING STOCK + ANY PURCHASES MADE - THOSE UNSOLD UNITS) * THE COST PER UNIT
WORK OUT THE COST OF GOODS SOLD FROM THE FOLLOWING DATA.

3) = GROSS PROFIT--

GROSS PROFIT = SALES REVENUE – COGS

+$350

--TASK--

COPY AND COMPLETE THE TABLE BELOW

4) LESS EXPENSES & OVERHEADS--

EXPENSES INCLUDES ALL INDIRECT COSTS.
This includes all FIXED COSTS such as rent and insurance which have to be paid regardless of output and sales as well as VARIABLE COSTS not directly involved in the production of the goods sold.
EXAMPLES include
- - WAGES & SALARIES of other staff
  - ELECTRICITY
  - RENT/INSURANCE
  - ADVERTISING etc...

For example, a donut shop must continue paying rent, utilities, and marketing costs, regardless of the number of GLAZED rings it sells in a given week.

($155)

5) = NET PROFIT--

NET PROFIT = GROSS PROFIT – EXPENSES

+$195

6) LESS TAX--

CORPORATION TAX

($35)

7) = AFTER-TAX PROFIT--

PROFIT AFTER TAX = NET PROFIT – TAX

+$160

8) LESS DIVIDENDS--

DIVIDENDS: SHARE of AFTER-TAX PROFIT given to shareholders.

($120)

9) = RETAINED PROFIT--

RETAINED PROFITS = PROFIT AFTER TAX – DIVIDENDS.
Retained earnings are then kept aside for use in the business.
Retained profits are critically IMPORTANT for a business because this CASH CAN BE INVESTED INTO NEW PROJECTS which can help the company continue to grow.
Some of this money CAN ALSO BE SAVED TO PROTECT THE BUSINESS from future issues that may be expensive to fix.

+$40

--TASK: 4-MARKERS--

--TASK--

WORK OUT X & Y.

--TASK--

--USED TO MAKE DECISIONS--

--TO SHOW PROFIT OR LOSS--

CLEARLY, INCOME STATEMENTS CAN BE USED TO SHOW WHETHER THE FIRM IS ULTIMATELY MAKING PROFITS OR LOSSES.

--TO SECURE FINANCE--

INCOME STATEMENTS ARE ANALYSED BY ANY POTENTIAL INVESTOR OR LENDER (BANKS) TO GAUGE THE FINANCIAL STRENGTH OF A COMPANY, PRIOR TO OFFERING FINANCE.

--TO SHOW SHAREHOLDER'S BIZ PERFORMANCE--

SHAREHOLDERS & POTENTIAL INVESTORS CAN USE THEM TO SEE IF THE BUSINESS IS MAKING RETAINED PROFITS, WHICH IMPLIES THAT IT IS INVESTING AND EXPANDING.
SIMILARLY, IF A FIRM IS CONTINUALLY PAYING TOO MANY DIVIDENDS, (LESS RETAINED PROFITS) IT IMPLIES THE FIRM IS NOT REINVESTING IN THE FIRM WHICH COULD BE A CONCERN FOR SHAREHOLDERS AND POTENTIAL INVESTORS.
EVEN IF A BUSINESS (USUALLY A START-UP) IS MAKING LOSSES, INVESTORS WILL BE INTERESTED IN SEEING IF THE LOSSES ARE GETTING PROGRESSIVELY SMALLER.

--TO COMPARE PERFORMANCE OVER TIME--

ARE GROSS/NET PROFITS INCREASING/DECREASING? WHY?
ARE SALES INCREASING/DECREASING? WHY?
ARE AVERAGE COSTS OF GOODS INCREASING/DECREASING? WHY?
ARE AVERAGE EXPENSES/OVERHEADS INCREASING/DECREASING? WHY?
ARE RETAINED PROFITS INCREASING/DECREASING? WHY?
ARE DIVIDENDS INCREASING/DECREASING? WHY?

--TO COMPARE PERFORMANCE WITH COMPETITORS--

INCOME STATEMENTS CAN BE USED TO COMPARE PERFORMANCES WITH PREVIOUS YEARS, AND WITH COMPETITORS.
THIS WAY THE FIRM CAN IDENTIFY IF THEY ARE PERFORMING POORLY IN RELATION TO THEIR COMPETITORS, AND IF SO CAN TAKE APPROPRIATE ACTION.
IT CAN INDICATE THAT THEY ARE TAKING MORE OR FEWER CUSTOMERS THAN THEIR RIVALS, INDICATING WHETHER THEY ARE BECOMING MORE OR LESS COMPETITIVE.

--PROFITABILITY OF INDIVIDUAL PRODUCTS--

INCOME STATEMENTS CAN SHOW IF INDIVIDUAL PRODUCTS/SERVICES ARE MAKING PROFITS OR LOSSES:
For example, is the OFS ENRICHMENT PROGRAMME PROFITABLE? Which activity loses money? Which activity is really profitable? Should we shut some down and expand others?

--PROFITABILITY OF NEW PRODUCTS--

MUCH LIKE CASHFLOW FORECASTS, INCOME STATEMENTS CAN ALSO BE FORECASTED.
THEREFORE, FORECASTED INCOME STATEMENTS FOR NEW PRODUCT LINES WILL LET THE FIRM KNOW WHICH PRODUCTS WILL GENERATE THE MOST PROFIT, SO THEY CAN INVEST FURTHER IN THEM WHILE GIVING UP ON THOSE LINES WHICH ARE ONLY FORECASTED TO GENERATE SMALL PROFITS OR EVEN LOSSES.

--EXEMPLAR--

"Yes, Asif has made the correct decision in this case. The net profit for location B is 30% higher than location A. On top of this, a new housing estate is planned for the area surround the shop at location B. This means that sales revenue will likely further increase in the future allowing the business to expand even more. At the end of the day, you should usually choose the shop location that will net you the greatest profit, which is location B so Asif made the correct choice".

--TASK--

--TASK: 4-MARKERS--

Page updated

Google Sites

Report abuse