(C) 2007 Prentice Hall, Inc.3-1 Income Statement and Statement of Stockholders’ Equity Learning about earnings, the bottom line, Is very important most of the time. A phony number Just may encumber Those folks trying to make more than a dime. --A. Ormiston

(C) 2007 Prentice Hall, Inc.3-2 The Income Statement Also called the Statement of Earnings Presents:RevenuesExpenses Net Income Earnings Per Share

(C) 2007 Prentice Hall, Inc.3-3 The Income Statement (cont.) Comes in two basic formats Multiple-stepSingle-step

(C) 2007 Prentice Hall, Inc.3-4 The Income Statement (cont.) Multiple-step Provides several intermediate profit measures prior to the amount of net earnings for the period:  Gross profit  Operating profit  Earnings before income taxes Should be used for purposes of analysis

(C) 2007 Prentice Hall, Inc.3-5 The Income Statement (cont.) Single-step Groups all items of revenue together, then deducts all categories of expense to arrive at a figure for net income

(C) 2007 Prentice Hall, Inc.3-6 The Income Statement (cont.)

(C) 2007 Prentice Hall, Inc.3-7 Common-Size Income Statement Useful analytical tool Expresses each income statement item as a percentage of net sales Shows the relative magnitude of various expenses relative to sales, the profit percentages, and the relative importance of “other” revenues and expenses

(C) 2007 Prentice Hall, Inc.3-8 Common-Size income statement (cont.) Comparison of two major retail companies* Comparison using $ ($ are in millions): Retailer A Retailer B Retailer A Retailer B Net Sales $ 287,989 $ 46,839 Cost of Sales 219,793 31,445 Operating Expenses 51,105 11,793 Net Income 10,267 3,198 *Data from SEC website,

(C) 2007 Prentice Hall, Inc.3-9 Common-Size income statement (cont.) Comparison of two major retail companies* Comparison using common size income statement %: Retailer A Retailer B Retailer A Retailer B Net Sales Cost of Sales Operating Expenses Net Income *Data from SEC website,

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(C) 2007 Prentice Hall, Inc.3-11 Net Sales Sales are generally reported net of sales returns and sales allowances A sales return is a cancellation of a sale A sales allowance is a deduction from the original sales invoice price

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(C) 2007 Prentice Hall, Inc.3-14 Net Sales—Related Issue Are sales growing in “real” (inflation- adjusted) as well as “nominal” (as reported) terms? An adjustment of the reported sales figure with the Consumer Price Index (or some other measure of general inflation) will enable the analyst to make a comparison of the changes in real and nominal terms

(C) 2007 Prentice Hall, Inc.3-15 Cost of Goods Sold (COGS)  Also called “Cost of Sales”  Cost to seller of products or services sold to customers  Important for profit determination  Largest expense item for many firms  Impacted by cost flow assumption used to value inventory  Cost of goods sold percentage is: Cost of goods sold Net sales

(C) 2007 Prentice Hall, Inc.3-16 Gross Profit  First step of profit measurement  Difference between net sales and COGS  Key analytical tool in assessing a firm’s operating performance  Gross Profit Margin is: Gross profit Net sales

(C) 2007 Prentice Hall, Inc.3-17 Operating Expense Have considerable impact on the firm’s current and future profitability Important to track carefully--trends, absolute amounts, relationship to sales, relationship to industry competitors

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(C) 2007 Prentice Hall, Inc.3-19 Operating Profit  Second step of profit measurement  Also called EBIT—Earnings Before Interest and Taxes  Measures overall performance of company’s operations: sales revenue less expenses associated with generating sales

(C) 2007 Prentice Hall, Inc.3-20 Operating Profit (cont.)  Provides a basis for assessing the success of a company apart from its financing and investing activities and separate from tax considerations  Operating Profit Margin is: Operating profit Net sales

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(C) 2007 Prentice Hall, Inc.3-24 Other Income (Expense) Revenues/expenses other than from operations Dividend and interest income Interest expense Investment gains/losses Equity earnings/losses Sales of fixed assets gains/losses Includes

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(C) 2007 Prentice Hall, Inc.3-27 Equity Earnings Two methods may be used to account for investments in voting stock of other companies of less than 50% EquityCost

(C) 2007 Prentice Hall, Inc.3-28 Earnings Before Income Taxes/ Effective Tax Rate  Earnings before income taxes is the profit recognized before deduction of income tax expense  Remember, income taxes paid may differ from income tax expense (deferred taxes)  Effective tax rate is: Income taxes Earnings before income taxes

(C) 2007 Prentice Hall, Inc.3-29 Special Items (cont.) Special Items (cont.) Are often one-time items that will not recur in the future Are often one-time items that will not recur in the future If companies are affected by the following three items, they must be disclosed separately on the income statement, net of income tax effects or retrospectively applied to prior periods’ financial statements: If companies are affected by the following three items, they must be disclosed separately on the income statement, net of income tax effects or retrospectively applied to prior periods’ financial statements: Discontinued operationsDiscontinued operations Extraordinary itemsExtraordinary items

(C) 2007 Prentice Hall, Inc.3-30 Discontinued Operations Occur when a firms sells or discontinues a clearly distinguishable portion of its business

(C) 2007 Prentice Hall, Inc.3-31 Net Earnings  Also called the “bottom line”  Represents the firm’s profit after consideration of ALL revenue and expense  Net profit margin is: Net earnings Net sales

(C) 2007 Prentice Hall, Inc.3-32 Earnings Per Common Share The net earnings available to common stockholders for the period divided by the average number of common stock shares outstanding

(C) 2007 Prentice Hall, Inc.3-33 Earnings Per Common Share (cont.) If firm has “complex” capital structure, it will report basic and diluted EPS Extensively used by analysts in evaluating a firm

(C) 2007 Prentice Hall, Inc.3-34 Earnings Per Common Share (cont.) Examples of basic and diluted EPS data reported by a variety of companies* Basic EPSDiluted EPS Airline$.70$.67 Grain Mill Recreation Retailer Semicond. Mfg *Data from SEC website,

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(C) 2007 Prentice Hall, Inc.3-36 Comprehensive Income The change in equity of a company during a period from transactions, other events, and circumstances relating to nonowner sources

(C) 2007 Prentice Hall, Inc.3-37 Comprehensive Income (cont.) Comprehensive Income (cont.) Companies are required to report total comprehensive income in one of three ways: 1. On the face of the income statement 2. In the statement of stockholders’ equity 3. In a separate statement of comprehensive income

(C) 2007 Prentice Hall, Inc.3-38 Comprehensive Income (cont.) Comprehensive Income (cont.) Currently, there are four items that may comprise a company’s other comprehensive income: 1. Foreign currency translation effects 2. Unrealized gains and losses 3. Additional pension liabilities 4. Cash flow hedges

(C) 2007 Prentice Hall, Inc.3-39 The Statement of Stockholders’ Equity Details transactions that affected the balance sheet equity accounts during an accounting period

(C) 2007 Prentice Hall, Inc.3-40 The Statement of Stockholders’ Equity (cont.) Basically, it simply explains how each account got from the balance at the beginning of the period to the balance at the end of the period and describes “events” that caused the balances to change

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