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Income Statement

All businesses are required to report sales and income over a taxation year.

Profits = Sales – Expenses

Net Income = Profits – Taxes

Categories included in an income statement:

Sales

Cost of sales

Gross profit

Operating Expenses

Other income

Depreciation and Amortization

Interest

Taxes

Extra ordinary expenses

Distributions

Sales:

Sales or gross income of a company is called revenue. Revenue recognition has a big importance. It is recognized when earned. i.e once the products sold are transferred or services are rendered.

Cost of sales:

These are costs that are directly related to production of goods. Most of the time it is cost of the material that is used in production of an item for sale.

Gross Profit:

When we subtract cost of goods sold from total revenue we get gross profit.

Gross profit margin = gross profit divided by total revenue.

Example:

Sales of a clothing company in its first quarter = 500,000

Cost of the material used = 200,000

Gross profit = Sales – COGS = 500,000 – 200,000 = 300,000

Gross profit margin = 300,000 / 500,000 = 60%

Operating Expenses:

Cost of normal business operations is called operating expenses.

Selling expenses, general and administrative expenses, research and development expenses are all examples of operating expenses.

Example:

In our example of clothing company let us assume the following:

Selling expenses = 100,000

Advertising expenses = 50,000

Research and development expenses = 50,000

Total operating expenses = 100,000 + 50,000 + 50,000 = 200,000

Other Income:

Other income is not a part of revenue because it is not related to main activities of a business.

Example:

Interest earned from financing

Income earned by having a non-controlling interest in another company

EBITDA:

EBITDA stands for earnings before interest, tax, depreciation and amortization.

EBITDA = Revenue – COGS – operating expenses and other income.

Other income usually has two arguments, it should be included in EBITDA or it should not be included in EBITDA.

If other income is consistent it should be added in EBITDA otherwise it should not.

Financial and lending organizations have different views about exclusion or inclusion of other income in EBITDA. Sometimes different industry groups with the same organization have different views on exclusion or inclusion of other income in EBITDA.

Example:

In our example above:

Sales = 500,000

Cost of sales = 200,000

Gross profit = 300,000

Total operating expenses = 200,000

We get income by subtracting operating expenses from gross profit therefore income = 300,000 – 200,000 = 100,000

Let us assume other income = 2,000

EBITDA = 100,000 + 2000 = 102,000

EBITDA marging = EBITDA / Revenue = 102,000 / 500,000 = 20.4%

EBIT:

EBIT = EBITDA – Depreciation

Let us assume that depreciation in our example = 2,000

EBIT = 102,000 – 2,000 = 100,000

EBIT margin = EBIT / Revenue = 100,000 / 500,000 = 20%

EBT (Earnings before taxes):

EBT = EBIT – Net interest.

Let us assume that interest expenses in our example = 20,000

EBT = 100,000 – 20,000 = 80,000

Taxes:

Business earning are subject to taxes. Let us assume that tax rate = 25%

Taxes due in our example = 80,000 x 25% = 20,000

Depreciation:

Fixed assets deplete over the years. Accounting for aging of assets is called depreciation. Accounting for aging of intangible assets is called amortization.

Non-recurring and extra ordinary items:

These are expenses or income that do not occur frequently and these are not related to main line of business. Gains or losses from sales of an asset is an example. Usually these items are mentioned separately after EBITDA and EBIT.

Distributions:

These are payments distributed to shareholders. Distributions are made in the form of dividends or interest.

Shares:

Basic shares are the share outstanding in the market.

Diluted shares are the number of shares outstanding if all possible sources of conversion, such as convertible bonds and stock options, were exercised.

Earnings per share:

Basic EPS = Net income / Basic shares

Diluted EPS = Net income / Diluted shares.

Disclaimer:

This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.

References:

Financial modeling and valuation by Paul Pignataro