Tuesday, 30 October 2012

Income Statement Analysis

Income Statement Analysis :

Revenue :

Amount realized by a company through sales.

Net Sales :

Sales minus Sales Returns represents Net Sales.

Net Sales= Sales – Sales Returns

Cost of Goods Sold:

Cost of goods sold is the accumulated total of all costs used to create a product or service, which has been sold. These costs fall into the general sub-categories of direct labor, materials, and overhead.

In a service business, the cost of goods sold is considered to be the labor, payroll taxes, and benefits of those people who generate billable hours ("Cost of Services").

In the income statement, the cost of goods sold is subtracted from revenues to arrive at the gross margin of a business.

Cost Of Goods Sold =Beginning Inventory + Purchases - Ending Inventory.

COGS also include Direct Costs such as:
  • Labor to produce the product, supplies used in manufacture or sale,
  • Shipping costs, costs of containers, freight in, and
  • Overhead costs directly related to the manufacture or production activity (like rent and utilities for the manufacturing facility).

The assumption is that the result, which represents costs no longer located in the warehouse, must be related to goods that were sold. Actually, this cost derivation also includes inventory that was scrapped, or declared obsolete and removed from stock, or inventory that was stolen. Thus, the calculation tends to assign too many expenses to goods that were sold.

Types of COGS:

There are two types of costs included in COGS:
  • Direct and
  • Indirect.
Direct Costs:
o        Cost to purchase the merchandise for resale.
o        Cost of raw materials.
o        Packaging costs.
o        Work in process.
o        Cost of inventory of finished products.
o        Supplies for production.
o        Direct overhead costs related to production (for example, utilities and rent for manufacturing facility).

Indirect Costs:

§         Manufacturing materials and supplies.
§         Labor (for workers who actually touch the product).
§         Costs to store/wholesale the products.
§         Salaries of administrators, managers overseeing production.

Factors Impacting COGS:

The cost of goods sold can also be impacted by the type of costing methodology used to derive the cost of ending inventory. Consider the impact of the following two inventory costing methods:

First In, First Out Method
Under this method, known as FIFO, the first unit added to inventory is assumed to be the first one used. Thus, in an inflationary environment where prices are increasing, this tends to result in lower-cost goods being charged to the cost of goods sold.

Last In, First Out Method
Under this method, known as LIFO, the last unit added to inventory is assumed to be the first one used. Thus, in an inflationary environment where prices are increasing, this tends to result in higher-cost goods being charged to the cost of goods sold.

Suppose  a company has $10,000 of inventory on hand at the beginning of the month, expends $25,000 on various inventory items during the month, and has $8,000 of inventory on hand at the end of the month. What was its cost of goods sold during the month? 
The answer is:

Beginning inventory
+ Purchases
- Ending inventory
= Cost of goods sold

The cost of goods sold can be fraudulently altered by a number of means in order to change reported profit levels, such as:

  • Altering the bill of materials and/or labor routing records in a standard costing system
  • Incorrectly counting the quantity of inventory on hand
  • Performing an incorrect period-end cutoff 
  • Allocating more overhead than actually exists to inventory

Gross Profit :
Gross Profit = Gross Sales – Cost of goods sold

The Gross profit must not be messed up with the operating income. In order to calculate operating income we require net income that is the different between the gross profit and operating expenses including taxes and interest payments. 

Operating Profit = Gross Profit – Total operating expenses

Net Profit :
Net Profit = Gross Profit – Operating Expense – Taxes – Interest Payments
Net Profit = Gross Profit – Indirect Expenses + Indirect Income



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