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

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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

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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