All businesses are required to report sales and income over a taxation year.
Profits = Sales – Expenses
Net Income = Profits – Taxes
Categories included in an income statement:
Sales
Cost of sales
Gross profit
Operating Expenses
Other income
Depreciation and Amortization
Interest
Taxes
Extra ordinary expenses
Distributions
Sales:
Sales or gross income of a company is called revenue. Revenue recognition has a big importance. It is recognized when earned. i.e once the products sold are transferred or services are rendered.
Cost of sales:
These are costs that are directly related to production of goods. Most of the time it is cost of the material that is used in production of an item for sale.
Gross Profit:
When we subtract cost of goods sold from total revenue we get gross profit.
Gross profit margin = gross profit divided by total revenue.
Example:
Sales of a clothing company in its first quarter = 500,000
Cost of the material used = 200,000
Gross profit = Sales – COGS = 500,000 – 200,000 = 300,000
Gross profit margin = 300,000 / 500,000 = 60%
Operating Expenses:
Cost of normal business operations is called operating expenses.
Selling expenses, general and administrative expenses, research and development expenses are all examples of operating expenses.
Example:
In our example of clothing company let us assume the following:
Selling expenses = 100,000
Advertising expenses = 50,000
Research and development expenses = 50,000
Total operating expenses = 100,000 + 50,000 + 50,000 = 200,000
Other Income:
Other income is not a part of revenue because it is not related to main activities of a business.
Example:
Interest earned from financing
Income earned by having a non-controlling interest in another company
EBITDA:
EBITDA stands for earnings before interest, tax, depreciation and amortization.
EBITDA = Revenue – COGS – operating expenses and other income.
Other income usually has two arguments, it should be included in EBITDA or it should not be included in EBITDA.
If other income is consistent it should be added in EBITDA otherwise it should not.
Financial and lending organizations have different views about exclusion or inclusion of other income in EBITDA. Sometimes different industry groups with the same organization have different views on exclusion or inclusion of other income in EBITDA.
Example:
In our example above:
Sales = 500,000
Cost of sales = 200,000
Gross profit = 300,000
Total operating expenses = 200,000
We get income by subtracting operating expenses from gross profit therefore income = 300,000 – 200,000 = 100,000
Let us assume other income = 2,000
EBITDA = 100,000 + 2000 = 102,000
EBITDA marging = EBITDA / Revenue = 102,000 / 500,000 = 20.4%
EBIT:
EBIT = EBITDA – Depreciation
Let us assume that depreciation in our example = 2,000
EBIT = 102,000 – 2,000 = 100,000
EBIT margin = EBIT / Revenue = 100,000 / 500,000 = 20%
EBT (Earnings before taxes):
EBT = EBIT – Net interest.
Let us assume that interest expenses in our example = 20,000
EBT = 100,000 – 20,000 = 80,000
Taxes:
Business earning are subject to taxes. Let us assume that tax rate = 25%
Taxes due in our example = 80,000 x 25% = 20,000
Depreciation:
Fixed assets deplete over the years. Accounting for aging of assets is called depreciation. Accounting for aging of intangible assets is called amortization.
Non-recurring and extra ordinary items:
These are expenses or income that do not occur frequently and these are not related to main line of business. Gains or losses from sales of an asset is an example. Usually these items are mentioned separately after EBITDA and EBIT.
Distributions:
These are payments distributed to shareholders. Distributions are made in the form of dividends or interest.
Shares:
Basic shares are the share outstanding in the market.
Diluted shares are the number of shares outstanding if all possible sources of conversion, such as convertible bonds and stock options, were exercised.
Earnings per share:
Basic EPS = Net income / Basic shares
Diluted EPS = Net income / Diluted shares.
Disclaimer:
This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.
References:
Financial modeling and valuation by Paul Pignataro
Mansoor Suhail (Mani)
Accountant
BSBA – EA – ICIA – RA
Tax for Canada and U.S.A
Web: www.theaccountingandtax.com and www.taxservicesguru.com
Blog: http://taxservicesguru.blogspot.ca
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