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Income Statement Analysis

economy












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Seminar: Corporate Finance

FABIZ, english section, Year of Study: II

Seminar: 3 -Income Statement Analysis



   &nbs 737b110h p;   &nbs 737b110h p;    1. What is the Income Statement?

Income statement is a financial statement listing an entity’s revenues, expenses, and net income or net loss for a specified period. Also called the statement of operations.

   &nbs 737b110h p;   &nbs 737b110h p;   􀃎 it is a “mirror” of firm’s performance at a given point in time.

Romanian Form of the Income Statement

   &nbs 737b110h p;   &nbs 737b110h p;    1. Sales Revenue

a. Sales of merchandises

   &nbs 737b110h p;   &nbs 737b110h p;   b. Sales of final products

   &nbs 737b110h p;   &nbs 737b110h p;   c. Final products inventory

   &nbs 737b110h p;   &nbs 737b110h p;   d. Final products used by the company

   &nbs 737b110h p;   &nbs 737b110h p;    2. Other operating revenues

   &nbs 737b110h p;   &nbs 737b110h p;   a. Company’s assets sales

   &nbs 737b110h p;   &nbs 737b110h p;   b. Operating subsidies

   &nbs 737b110h p;   &nbs 737b110h p;    3. Operating expenses

   &nbs 737b110h p;   &nbs 737b110h p;   a. Raw materials’ cost

   &nbs 737b110h p;   &nbs 737b110h p;   b. Energy cost

   &nbs 737b110h p;   &nbs 737b110h p;   c. Cost of services

   &nbs 737b110h p;   &nbs 737b110h p;   d. Payroll expenses

   &nbs 737b110h p;   &nbs 737b110h p;   e. Other taxes (on buildings, on land etc.)

   &nbs 737b110h p;   &nbs 737b110h p;   f. Depreciation expenses

   &nbs 737b110h p;   &nbs 737b110h p;   g. Other expenses

   &nbs 737b110h p;   &nbs 737b110h p;    4. OPERATING INCOME

   &nbs 737b110h p;   &nbs 737b110h p;    5. Financial revenues

   &nbs 737b110h p;   &nbs 737b110h p;    6. Financial expenses

   &nbs 737b110h p;   &nbs 737b110h p;    7. FINANCIAL INCOME

   &nbs 737b110h p;   &nbs 737b110h p;    8. CURRENT INCOME

   &nbs 737b110h p;   &nbs 737b110h p;    9. Extraordinary revenues

   &nbs 737b110h p;   &nbs 737b110h p;    10. Extraordinary expenses

   &nbs 737b110h p;   &nbs 737b110h p;    11. EXTRAORDINARY INCOME

   &nbs 737b110h p;   &nbs 737b110h p;    12. EARNING BEFORE TAXES

   &nbs 737b110h p;   &nbs 737b110h p;    13. Income tax

   &nbs 737b110h p;   &nbs 737b110h p;    14. NET INCOME

The Anglo-Saxon Form of the Income Statement

1. Sales Revenue. Often called the "top Line" this represents the amount the company has sold during the period.

2. Cost of Goods Sold. Is the expense a company incurred in order to manufacture, create, or sell a product. It includes the purchase price of the raw material as well as the expenses of turning it into a product.

3. Gross Profit or (Loss). This is the difference between Sales Revenue and Cost of Goods Sold. If the difference is positive, and it had better be, it is profit. A negative difference is a loss and is shown in brackets.

4. General & Administrative expenses are called G&A. These are the costs associated with running the company as opposed to the costs of making or buying the products (CGS above). These costs should be monitored closely and kept as low as possible.

5. Sales & Marketing expenses. These are other costs not directly related to producing the product or service to be sold. While certainly necessary, sales and marketing costs should be monitored and compared frequently to similar numbers from other companies in the same industry with products in the same point in the life cycle.



6. Research & Development (R&D) expenses. This is the part of its income a company is re-investing in the business to find and develop new products. It's an indication of how much management values innovation. Look at whether it is increasing or decreasing from year to year.

7. Operating Income. This is what's left when you subtract all the operating expenses from Gross Profit

8. Income Before Taxes. After subtracting any interest paid on outstanding debt from Total Operating Income you are left with Income Before Taxes. This is the amount on which the company expects to have to pay taxes.

9. Taxes. This is the amount the company has paid or expects to pay in taxes for the period. It includes all taxes to all jurisdictions.

10. Net Income From Continuing Operations. After subtracting taxes from its income, this is what the company has left. Think of it like a workers take-home pay.

11. Profit Margin. This varies from industry to industry, but is a good measure to compare similar companies, from either an investment or a benchmarking perspective. It's like the interest rate you get on your investment.


12. Non-recurring Events. This is the cost of any one-time expenses, for instance, restructuring the business, a major layoff, or an un-reimbursed casualty loss. These are shown on a separate line so as to not confuse the "continuing operations" figure above.

13. Net Income. This is what the company has left after subtracting all its expenses from its total revenue. If the difference is positive it is profit. A negative difference is a loss and is shown in brackets. For a company to remain healthy and in business, this number needs to be positive most of the time. Most for-profit companies strive to make it as big a positive number as possible.

14. Dividends to Shareholders. Companies pay dividends to the shareholders who own the companies. If any dividends have been paid during the period being reported, they are shown on this line. These can be to common stock holders, preferred stock holders, or other investors depending on the company. Dividends usually are paid only once a year.

15. Net Income Available to Shareholders. This is "the bottom line". This is the money the company has left at the end of the period. It is held for future needs, invested as the Board directs, or returned to investors in the future.

  1. During 2005 LOVELY Co. had the following performances:

Operating Revenues                                        920,000 RON

Cost of Goods Sold                                        (710,000) RON

Selling, general and administrative expenses (98,000) RON

Depreciation                                                   (9,000) RON

Operating Income                                           103,000 RON

Other Income                                                             0 RON

Other Expenses (except Interest)                                0 RON

Earnings Before Interest And Taxes (EBIT)     103,000 RON

Interests                                                          (43,000) RON

Earnings Before Taxes (EBT)                          60,000  RON

Corporate Income Tax (50%)                         (30,000) RON

Net Income                                                    30,000 RON

                                  

a)   &nbs 737b110h p;  Analyze types of revenues and costs

b)   &nbs 737b110h p;  What is the connection between the IS and the BS of Lovely Co. (Depreciation, Accumulated retained earnings)

c)   &nbs 737b110h p;  Build the Statement of Changes of Equity

Statement of Changes in Equity

Accumulated retained earnings, December 31st 2004: 113,000 RON

Net Income                                                                      30,000 RON

Dividends Paid                                                    (5,000) RON

Accumulated retained earnings, December 31st 2005: 138,000 RON

  1. The data of the ALFA Co’s Income Statement for 2005 are as follows:

-   &nbs 737b110h p;   &nbs 737b110h p; sales revenues: € 32,000

-   &nbs 737b110h p;   &nbs 737b110h p; salaries: :  € 3,000

-   &nbs 737b110h p;   &nbs 737b110h p; interest expenses: :  € 500

-   &nbs 737b110h p;   &nbs 737b110h p; raw materials expenses:  € 8,000

-   &nbs 737b110h p;   &nbs 737b110h p; depreciation and amortization: :  € 1,000

-   &nbs 737b110h p;   &nbs 737b110h p; other expenses with services and materials: :  € 8,000

-   &nbs 737b110h p;   &nbs 737b110h p; taxes on land and buildings: :  € 100

-   &nbs 737b110h p;   &nbs 737b110h p; corporate income tax: :  € 100

a)   &nbs 737b110h p;  build the IS (anglo-saxon and Romanian approach)

b)   &nbs 737b110h p;  determine the Value Added and its allocation

c)   &nbs 737b110h p;  if the allocation of value added in 2004 was: 10% to employees, 30% to creditors, 15% to the state, 5% to the company and 40% to the shareholders, comment the evolution of value added allocation and identify possible future problems.

  1. Berry Corporation produces tea pots which are sold with $15/piece. For any production of less than 400,000 pieces the value of fixed costs is $700,000. The variable cost is $10/piece.

a) what is the profit of the loss if the volume of sales is 125,000 pieces? But what if is 175,000 pieces?

b) what is the level of breakeven point? Draw it!

c) what is the operating leverage? If the average level of operating leverage in the field of tea pot production is 2.5 comment Berry Corporation’s risk of operating activities compared to its competitors.

Short quiz:




   &nbs 737b110h p;   &nbs 737b110h p;    􀀵 What is the income statement equation?

   &nbs 737b110h p;   &nbs 737b110h p;    􀀵 What is the difference between Romanian Form and Anglo-Saxon Form of the income statement?

   &nbs 737b110h p;   &nbs 737b110h p;    􀀵 Which things should be kept in mind when looking at an income statement?

   &nbs 737b110h p;   &nbs 737b110h p;    􀀵 Which is the most important piece of information we have to look for in a income statement, as stockholders (creditors, or other stakeholders)?

   &nbs 737b110h p;   &nbs 737b110h p;    􀀵 Which part of a debt payment is registered in the income statement?

   &nbs 737b110h p;   &nbs 737b110h p;    􀀵 Is the payment for an investment (in a building, or equipment) registered in the income statement?

   &nbs 737b110h p;   &nbs 737b110h p;    􀀵 What are non-cash expenses? Give some examples!


Breakeven point analysis

Which are the sales revenues (quantity of goods) the company has to make in order to cover all its cost (variable and fix)?

   &nbs 737b110h p;   &nbs 737b110h p;    - the sales revenues at breakeven point

   &nbs 737b110h p;   &nbs 737b110h p;    - the quantity of goods at breakeven point

In order to estimate the sales revenues (quantity of goods) at breakeven point you need to sort the company’s expenses in fix and variables.

Variable expenses are those which are relied with the production process and vary when the quantity of goods produced is changing.

The profit margin over the variable cost (expenses) will be used to cover the company’s fixed cost. If the company succeeds to cover its fixed cost, this margin will be transformed in profit.

Degree of operating leverage

Measure the company’s operating risk. High levels of this indicator indicate a high risk of the company’s operations. The company’s management should keep a law level of this indicator.

Ways of decreasing the degree of operating level:

   &nbs 737b110h p;   &nbs 737b110h p;    - by diminishing fixed cost;

   &nbs 737b110h p;   &nbs 737b110h p;    - by decreasing variable cost;


Short problems:

1. A manufacturer contemplates a change in technology that would reduce fixed costs from $800,000 to $600,000, and reduce depreciation expense from $125,000 to $100,000. However, the ratio of variable costs to sales will increase from 68% to 80%. What will happen to break-even level of revenues?

a) A reduction to the level of $875,000.

b) A reduction to the level of $2,890,625.

c) An increase to the level of $3,500,000.

d) An increase to the level of $3,625,000.

2. For a firm with a DOL (degree of operating leverage) of 3.5, an increase in sales of 6% will:

a) increase operating profits by 3.5%.

b) decrease operating profits by 3.5%.

c) increase operating profits by 21 %.

d) increase operating profits by 1.71%.

3. How much does each additional sales dollar contribute toward profit for a firm with $4 million break-even level of revenues and $1.2 million in fixed costs including depreciation?

a) $0.30;

b) $0.33;

c) $0.50;

d) $0.67;

4. The degree of operating leverage of a company is 4. The company’s sales are $100.000 mil. and its fixed cost are $30.000 mil. Which is the level of the sales the company has to make in order to get a profit of $20.000 mil.?

a) $125.000 mil. b) $ 85.000 mil.; c) $50.000 mil.; d) $140.000 mil.; e) $150.000 mil.

HOMEWORK:

1. Assume that the financial statements for Lillian's Bakery reveal that the bakery's fixed costs are $49,000, and its variable costs per unit of production (loaf of raisin coffee cake) are $.30. Further assume that its sales revenue is $1.00 per loaf.

Determine the quantity that has to be produced so ad Lilian’s Bakery reaches the breakeven point. What is the value of sales revenues at breakeven?

2. We know the following data for BETA Co:

-   &nbs 737b110h p;   &nbs 737b110h p; sales revenues: $10,000, obtained from selling 1,000 pairs of shoes

-   &nbs 737b110h p;   &nbs 737b110h p; variable operating costs: $5,000

-   &nbs 737b110h p;   &nbs 737b110h p; depreciation: $2,000

-   &nbs 737b110h p;   &nbs 737b110h p; interests: $1,000

a)   &nbs 737b110h p;  determine the operating breakeven point in quantity and sales revenues

b)   &nbs 737b110h p;  If sales increase by 20% what is the value of operating leverage?

c)   &nbs 737b110h p;  If sales increase with an additional 10%, what will be the increase in EBIT?













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