Income statement

Aqhuman financial training & coachingwww.aqhuman.com

Financial Awareness

Income Statement


The Income Statement

Let us build a format: Revenue (sales, turnover) 500Cost of sales (100)Gross profit 400Operating costs (100)Operating profit 300



Let us build a format: Revenue (sales, turnover) 500Cost of sales (100)Gross profit 400Operating costs (100)Operating profit 300

Recall that we speak of “above the line”; this represents the

operational activities of the business



Let us build a format: Revenue (sales, turnover) 500Cost of sales (100)Gross profit 400Operating costs (100)Operating profit 300Interest ( 50)Profit before tax 250Taxation ( 75)Profit attributable to shareholders 175

Below the line refers to “treasury” matters;

dealing with tax planning and financing.

The International income statement

finishes here:



Let us build a format: Revenue (sales, turnover) 500Cost of sales (100)Gross profit 400Operating costs (100)Operating profit 300Interest ( 50)Profit before tax 250Taxation ( 75)Profit attributable to shareholders 175Dividends (100)Retained earnings 75

Whereas the UK gaap profit and loss account continues to show the

dividend. Under IAS this information is shown in

the notes.


Revenue recognition (or when is a sale a sale?)

Above is a flight booking transaction. When does the airline count this as a sale (that is, recognise the sale in its income statement)?

10 Feb: booked 10 March: paid 30 March: year end

10 April: tickets arrive

10 May: fly


Revenue recognition (or when is a sale a sale?)

Above is a flight booking transaction. When does the airline count this as a sale (that is, recognise the sale in its income statement)?

When the flight is taken; a sale is a sale when the goods or services are delivered. Note: it does NOT follow the cash, that is why we have a separate cash flow statement.

10 Feb: booked 10 March: paid 30 March: year end

10 April: tickets arrive

10 May: fly

x


Revenue recognition

So it is important to get the salein the right year as the costsgo in the same year. Sales in

the wrong year + costs in the wrongYear = profit in the wrong year!


Revenue recognition: another example

A landlord collects the rent quarterly in advance; £100,000 on 24th March 2011. His year end is the 31st March 2011. How much rent goes in the income statement for the year end 31 March 2011?


Revenue recognition: another example

A landlord collects the rent quarterly in advance; £100,000 on 24th March 2011 . His year end is the 31st March 2011. How much rent goes in the income statement for the year end 31 March 2011?

7 days worth (say £8,000). The cash flow for that year is £100,000; the amount received.

The remaining £92,000 is shown on the balance sheet as a liability (“deferred income”); the tenant has paid

for something they have yet to receive.


Costs

Revenue (sales, turnover) 500Cost of sales (100)Gross profit 400Operating costs (100)Operating profit 300

What is the difference between these two types

of cost?

Aqhuman financial training & coaching

Costs

A cost of sale is closely associated with the company’s product, for example...

raw material, production labour, factory costs


Costs

A cost of sale is closely associated with the company’s product, for example...

raw material, production labour, factory costs

Whereas operating costs are more remote, such as...

human resources, accounting, legal, IT


Cost of sales and the matching principle

A retailer buys 100 tins of beans at £1 a tin. In the year he sells 20 for £3 a tin each. What is his profit?

Sales (20 x £3) 60Cost of sales (20 x £1) (20) Profit 40


Cost of sales and the matching principle

A retailer buys 100 tins of beans at £1 a tin. In the year he sells 20 for £3 a tin each. What is his profit?

Sales (20 x £3) 60Cost of sales (20 x £1) (20) Profit 40

We have sold 20 so we only bring in the cost of 20. This is the matching principle. Note that the retailer’s cash flow is £100 but the p&l cost is only £20


Costs and assets

Recall that the retailer spent (cash)Of this £20 was taken as a cost tothe income statement

What does the remaining represent?

£100

(£20)

£80


Costs and assets

Recall that the retailer spent (cash)Of this £20 was taken as a cost tothe income statement

What does the remaining represent?

This is, of course, stock (or inventory)and will appear as an asset on the balance sheet

£100

(£20)

£80


Cost and assets

Cash expenditure £100£20 cost £80 assetincome statement balance sheet

Costs are expenditure where the benefit has been received (the retailer bought the tins in order to sell them; 20 have been sold, so there is no further benefit to come from those).


Cost and assets

Cash expenditure £100£20 cost £80 assetincome statement balance sheet

Costs are expenditure where the benefit has been received (the retailer bought the tins in order to sell them; 20 have been sold, so there is no further benefit to come from those).

Assets represent expenditure where the benefit is yet to come (there are 80 unsold tins; the benefit will arise when the retailer sells them)


DepreciationYou buy some equipment, today, for £10,000. You estimate that it has a 5 year life, when you will scrap it.

Balance 10sheet

Income statement

Cash flow (10)

Today

Today; all of the benefit of owning the equipment lies

in the future. So the expenditure is entirely an

asset



Balance 10 10Sheet (2)

8Income Statement (2)

Cash flow (10)

Today

A year later 1/5th of the expected benefit has been

used; so 1/5th of the spend is now a cost. This is

depreciation

1



Balance 10 10Sheet (2)

8Income Statement (2)

Cash flow (10)

Today 1 2

10 10 10 10(4) (6) (8) (10) 6 4 2 -

(2) (2) (2) (2)

3 4 5


Dividend policy

What factors do the directors of a business use to decide the level of dividends?


Dividend policy

What factors do the directors of a business use to decide the level of dividends?

Investment for growth (and thereforethe maturity of the business)

Has the company made a profit?Does it have the cash to make the payment?

What dividend yields are the shareholders expecting?Does it need to reduce gearing?


Retained earnings (or profits)

Revenue (sales, turnover) 500Cost of sales (100)Gross profit 400Operating costs (100)Operating profit 300Interest ( 50)Profit before tax 250Taxation ( 75)Profit attributable to shareholder 175Dividends (100)

Retained earnings 75

These profits here belong

to the shareholders





The dividends represent the

amount that the shareholders

withdraw





Which leaves the retained earnings; the shareholders’ profits that they choose to

leave behind in the business. By leaving the profits behind

they have increased their investment, or equity


Income statement; summary

•Sales are sales when the goods or service are delivered•Costs represent expenditure where the benefit has been received (for example cost of sales where the sale has been made)•Profit does not follow the cash (hence profitable companies fail all the time; insolvency is entirely a cash matter) •Dividends decisions are driven by cash flow and shareholder expectations


Aqhuman Financial Training

Aqhuman’s principal is Kevin Amor, FCA. Kevin qualified as a chartered accountant with PWC. He spent 12 years working in commerce at financial controller/director level. Kevin now has more than 12 years experience in financial training. He trains managers at all levels and gives 1 to 1 financial coaching to senior executives.He also teaches corporate finance andaccounting for a number of business schools’ MBA programmes.

Income statement

Economy & Finance

Transcript of Income statement