Page 273 - DMGT104_FINANCIAL_ACCOUNTING

Unit 12: Corporate Financial Statements

statement is a type of summary flow report that lists and categorizes the various revenues and Notes
expenses that result from operations during a given period - a year, a quarter or a month. The
difference between revenues and expenses represents a company’s net income or net loss. The
amounts shown in the income statement are the amounts recorded for the given period – a year,
a quarter or a month. The next period’s income statement will start over with all amounts reset
to zero.
While the balance sheet shows accumulated balances since inception, the income statement only
shows the amounts earned or expensed during the period in question. Some of the key indicators
reported on the income statement include:

 Revenues are simply the annual incoming revenue flow, usually broken into different
categories (reflecting the different lines of the company’s business).
 Operating expenses include the expenses directly associated with the firm’s day-to-day
operations, including wages and salaries, benefits, supplies, parts, raw materials, rents
and leases, etc. This is sometimes called the company’s “cost of sales.”

 Operating profit equals revenues minus direct operating expenses, before deducting certain
overhead costs (such as interest expenses, R&D costs, restructuring charges, etc.) which are
associated with the firm’s overall existence (rather than with its specific day-to-day
operations). A strong operating profit is a sign of the inherent underlying profitability of
the company’s real business activity.
 Other deductions are then subtracted from the company’s operating profit, to generate an
estimate of its final bottom-line profitability. Two of the most important of these are
interest costs and depreciation. Interest costs are the actual cash payments made to banks
and other lenders (including bondholders) from whom the company has borrowed money
to finance its various activities. Depreciation, on the other hand, is an imaginary charge
that reflects the gradual wearing out of the actual machinery, equipment, buildings, and
other real assets which the firm uses in its business. The company doesn’t actually have to
“pay” anyone for this wear-and-tear, but it does have to recognise in its income statement
the inevitable decline in the value of these assets.
 Special one-time charges are also sometimes deducted at this stage of the income statement,
including one-time payouts for severance costs and other expenses associated with layoffs
or downsizing, or one-time “write-offs” of capital value by companies who are experiencing
chronic losses. In some cases, a researcher will want to analyse a company’s profits before
these special one-time charges, in cases where you want to demonstrate the continuing
viability of a company’s core business (a picture which can be clouded by one-time charges).
 Net income before tax equals the overall final profit of the company after all these various
charges are considered.

 Net income is the company’s final profit, after deducting a charge for income tax. If the
company has generated a before-tax loss, sometimes the income tax charge is positive,
since the company can set these losses against other profits (historical or anticipated) to
reduce its tax payments; this is called a “tax recovery.” Some income statements will
provide additional details on how this net income is distributed between different
categories of the company’s owners. For example, many companies have “preferred
shareholders,” who may receive a special dividend out of the company’s profits, before
any remaining profits are ascribed to the company’s other or “common” shareholders.
But if it is the profitability of the company that you are interested in, not the well-being of
a particular group of shareholders, then you will want to analyse the company’s net
income before any distributions to preferred shareholders.

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