Discussion Post

Summary Notes: A3—Income Statement and Statement of Retained Earnings
1
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
2
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