Agribusiness Library LESSON L060088: DEVELOPING AN INCOME STATEMENT

Objectives 1. Define revenue, and identify examples of cash and non-cash revenue. 2. Define expense, and identify examples of cash expenses and non-cash expenses. 3. Define income statement, and list the functions of an income statement.

Objectives 4. Compare and contrast cash and accrual accounting, and demonstrate the ability to develop an income statement for an agricultural business using cash or accrual accounting. 5. Calculate business profitability ratios.

Terms Accrual accounting Asset turnover Cash accounting Cash expenses Cash revenue Expense Gross margin Gross profit margin Income statement Net margin

Terms Non-cash expenses Non-cash revenue Operating expenses ratio (OER) Operating margin Operating profit margin Profit margin Return on assets (ROA) Return on equity Return on investment (ROI) Revenue

Revenue is income or return on an investment. The two major types of revenue are cash and non-cash revenue. A. Cash revenue is income, in cash form, that is received. Examples of cash revenue include wages earned, cash sales of produced goods, livestock, crops, bedding plants, or cash received in exchange for provided services.

B. Non-cash revenue is income for a business in the form of inventory or investments; no actual cash is received. Examples of non-cash revenue are capital gains on investments, increases in accounts receivable, or improvements in inventory that would increase the change in inventory.

An expense is money paid for products or services to operate a business. The two main types of expenses are cash and non-cash expenses. A. Cash expenses are money paid in exchange for products or services necessary to operate a business. Operating expenses include input costs to produce a product or costs associated with a necessary service. For example, a livestock operation might have cash expenses (e.g., feed, medical, and veterinary costs). A vegetable farmer could incur cash expenses (e.g., seed, fertilizer, transportation, and advertising costs).

B. Non-cash expenses are monetary value lost from a business without actually exchanging cash. One example of a non-cash expense is depreciation (the decline in value over time) of inventory, such as equipment or machinery. Another example of a non-cash expense is accrued interest (the cost associated with a loan).

An income statement is a record of all income and expenses that determines the net profit of a business over a specified period of time, normally one year. Income statements have multiple purposes. A. Income statements help identify possible income sources. B. Income statements provide an itemized list of expenses incurred by the business. C. Income statements predict future business performance.

The two major types of accounting are the cash and accrual methods. A. Cash accounting is the simplest form of accounting; it involves recording income when cash is received and records expenses when money is paid out. This form of accounting is good for small businesses who do mostly cash transactions.

B. Accrual accounting is the most common method of accounting; it involves recording income and expenses as they are incurred, regardless of when cash is actually transacted. Most large businesses use the accrual method as their major method of accounting. Income statements are composed and printed periodically (monthly, quarterly, or annually) to more accurately assess the financial status of the business.

Income statements use several profitability ratios to more accurately assess the success of the business. Some of those ratios are: A. Gross margin indicates how much money a business is making after it subtracts production expenses. A higher percentage indicates the business has more money to spend on growth and expansion. It is calculated by taking gross income divided by net sales.

B. Profit margin measures the amount of actual profitability after tax deductions for a 12-month period. It is calculated by taking the net profit after taxes divided by sales. C. Operating margin is a percentage that more accurately determines business profitability because it is does not take into consideration depreciation and taxes. It is calculated by taking operating income divided by revenues and is written as a percentage.

D. Net margin (net profit margin) is a percentage that indicates the ability of the business to effectively manage cost control. This value is often used to compare businesses that produce similar things. However, net margin is sometimes used to compare business that produce different products to evaluate the percentage of actual profit per dollar of expense. Net margin is calculated by taking net profit divided by net revenues.

E. Gross profit margin indicates the amount of money remaining from sales after accounting for the production expenses for the product. It is calculated by taking gross profit divided by sales, and it is expressed as a percentage. F. Operating profit margin is a measure of how effective a business is at controlling its expenses in a normal business operation. It is calculated by taking the operating profit for a certain period of time divided by revenues for that period.

G. Return on equity (ROE) is a calculation that measures the ability of a business to turn reinvested earnings into additional profit or earnings. It is calculated by taking net income divided by the shareholders equity. It is expressed as a percentage. H. Return on investment (ROI) is a measure of profitability that determines how effective a business is at using its capital investments to generate profit. It is calculated by taking the fiscal years income divided by common stock and preferred stock equity, plus long- term debt.

I. Return on assets (ROA) indicates business profitability. It is calculated by taking a fiscal years earnings divided by its total assets and is written as a percentage. J. Asset turnover (total asset turnover) indicates the ability of the business to utilize its assets to produce revenue. In its most general use, asset turnover is calculated by taking net sales divided by total assets. However, it is often calculated for specific assets (e.g., cash, fixed assets, and value of inventory). In each of these cases, the specific asset is divided by total assets.

K. Operating expenses ratio (OER) is a calculation that indicates how efficiently an income producing property is being managed. A lower number indicates a greater profit margin for investors. It is calculated by taking operating expenses divided by effective gross income.

REVIEW What is revenue, and what are some examples of cash and non-cash revenue? What is an expense, and what are some examples of cash and non-cash expenses? What is an income statement, and what is its function?

REVIEW What are the differences between cash and accrual accounting? How do you calculate business profitability ratios?