8 Chapter 8- Income Statements

An income statement, commonly referred to as a profit and loss statement, is a financial document that presents a company’s revenues, expenses, and resulting profit or loss for a specific month. It shows how much money a company brought in (revenue) and how much it spent (expenses) during that time. The primary purpose of an income statement is to determine the company’s net Income, which is the profit or loss for the period. The income statement also sets goals such as increasing revenue and profitability and decreasing expenses.

Income statements are used for various purposes by different stakeholders:

• Management: Businesses use income statements to track their profitability, identify areas for cost reduction, and assess their overall financial health.

• Investors: Investors use income statements to evaluate a company’s past performance and future profitability potential before making investment decisions.

• Creditors: Lenders use income statements to assess the company’s ability to repay loans.

INCOME STATEMENT TERMINOLOGY

• Sales/Revenue: The total Income from the company’s core business activities, like selling products or services.
  • Food Sales
  • Beverage Sales
  • Total Sales: Food Sales + Beverage Sales = Total Sales

• Cost of Sales: These are the costs incurred when purchasing food & beverage products to sell.
  • Food Cost: This is the primary component and includes the Cost of all the ingredients used to prepare menu items.
  • Beverage Cost: This includes the Cost of all the beverages you sell
  • Total Costs: Food Cost + Beverage Cost = Total Costs

• Gross Profit: Total Sales – Total Cost of Sales = Gross Profit

• Expenses: These are the costs incurred by the company to generate revenue and run the business.
  • Salaries: The Cost associated with paying salaries
  • Wages: The Cost associated with paying hourly workers
  • Direct Operating Cost: The Cost associated with operating the business.
  • Music & Entertainment: The Cost of providing guests with music or entertainment.
  • Marketing: The Cost of marketing the food & beverage operation to drive sales.
  • Utility Services: The Cost associated with the gas and electricity used to operate a business.
  • Repairs & Maintenance: The Cost associated with repairs and maintaining a business.
  • Occupancy Costs are the costs associated with a business occupying and maintaining the physical space in which it operates.
  • Depreciation: Represents the systematic reduction in the book value of an asset as it diminishes in utility or worth through use, age, or passage of time
  • General and Administrative:
  • Interest is the Cost of borrowing money from lenders to fund a company’s operations, such as working capital or capital expenditures.
  • Total Operating Expenses: All expenses added up equal total operating costs.

• Net Income (or net loss) is revenue minus expenses. There is a profit if the revenue dollar amount exceeds the expense dollar amount. There is a loss if the cost dollar amount exceeds the revenue dollar amount.

A common-size income statement is a peculiar way of presenting a regular income statement. In this statement, each line item is shown as a percentage of a base figure instead of a dollar amount. This base figure is typically the company’s total revenue or sales.

Common-size income statements are helpful tools for financial analysis. However, they should be used in conjunction with other financial data and industry benchmarks to get a complete picture of a company’s financial health.

Here is what a common-size income statement helps you do:

• Compare performance over time: By expressing everything as a percentage of revenue, you can quickly see how different expense categories (like Cost of goods sold or operating expenses) have changed as a proportion of sales over different periods. This helps identify trends and assess if a company is becoming efficient in managing its costs.

• Compare companies in the same industry: Since common-size statements use percentages, you can directly compare the financial performance of companies within the same industry, even if they have different revenue figures. This allows you to see how a particular company stacks up against its competitors regarding profitability and expense management.

To Determine the Food Sales, Beverage Sales, and Total Sales Percentages 

To Determine Food Cost % 

To Determine Beverage Cost %

To Determine the Total Cost of Sales % 

To Determine the Gross Profit % 

To Determine the Operating Expenses % 

To Determine Income Before Tax 

Income Before Taxes $34,300 / Total Sales $500,000 = 6.9%

A horizontal income statement, or comparative income statement, is not a different type of statement. It is a different way to analyze an income statement by comparing financial performance across multiple periods.

Horizontal Analysis: This technique compares line items in the income statement across multiple periods. Imagine placing two or more income statements side-by-side.

The horizontal income statement typically shows the following for each line item:

• Original Amount: The actual dollar amount reported in the base period (often the most recent period).

• Amount in Subsequent Periods: The dollar amount for the same line item in other periods you are comparing to.

• Change (Amount or Percentage): This shows the increase or decrease in the line item compared to the base period. This can be expressed as a difference in dollar amounts or a percentage change.

By analyzing these changes, you can identify company performance trends. Here are some benefits of using a horizontal income statement:

• Spotting Growth Trends: You can see if revenue, expenses, or profit margin trends increase or decrease over time.

• Identifying Areas for Improvement: Significant changes in expense categories might indicate areas where cost-saving measures could be implemented.

• Evaluating Strategies: You can assess the impact of past business decisions by comparing financial performance before and after the strategy was implemented.

Overall, the horizontal income statement and other financial documents are valuable for understanding how a company’s financial performance has changed over time.

Here is an example of a horizontal income statement we will use in this course. Note that we are comparing two periods of time, August and September.

We calculate Columns A and B just as we did with the Common Size Income Statement, working top to bottom, but with a horizontal income statement. Column C is labeled the amount column, and Column D is the percentage column. Columns C and D are calculated differently than a Common Size Income Statement.

We will use the following formula: 

• Column B – Column A = Column C
• Column C / Column A. = Column D