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Introduction To The Income StatementThis is the downloaded transcript of the video presentationfor this topic. More downloads and videos are available ysisTheKaplanGroupCommercial Collection AgencySuperior Results Since 1991!www.kgaction.com!805-541-2639More Videos and downloads at The Kaplan analysis The Kaplan Group!

TheKaplanGroup Introduction to The Income StatementHi. This is Dean Kaplan. The Kaplan Group is a commercial collection agencyspecializing in debt collection of large business to business claims.CREDIT MANAGER SEMINARSThis video series introducing you to financial statement analysis is based on the dozensof training seminars I have given to credit industry groups organized by Dun &Bradstreet, the National Association of Credit Management and Riemer ReportingServices. It is applicable to anyone wanting to learn about this topic, although onoccasion I will highlight information from the perspective of credit management.3 FINANCIAL STATEMENTSCash Flow StatementFor the Year Ended December 31, 2011 (000s)Cash Flows From Operating ActivitiesNet Income397Depreciation and amortization318Unrealized gain on marketable securitiesDecrease (increase) in deferred taxes(12)BalanceSheet(44)As of December 31, 2011 (000s)Net increase (decrease) in receivables, inventories, prepaids, payablesTotal Cash Flows From OperatingActivitiesAssetsCashCash Flows From Investing Activities(97)562 Liabilities481Accounts PayableSecuritiesPurchase of machinery, equipment, Marketableand improvements1,346(230) Current Portion L-T DebtDecrease (increase) in employee advancesAccounts ReceivableProceeds from the sale of marketablesecurities StatementIncome1,677(60) Taxes PayableInventory2,93622Accrued Expenses6251,02136157Purchase of marketableForsecurities(96)the YearPrepaidEndedExpensesDecember 31, 2011 (000s)172 Total Current LiabilitiesDecrease (increase) in notes receivable(46)1,839TotalCurrent AssetsTotal Cash FlowsInvestingActivitiesCostFromof GoodsSold6,670427 Long-term9,905 Debt2,332TotalLiabilities1,9874,171Salesin depositsDecrease (increase)Other Current Assets58(17) 11,892Cash Flows FromFinancingGrossProfit ActivitiesNew short-term borrowingsGross Value of Property,Plant & EquipmentDevelopmentRepayment ofResearchshort-term &borrowingsAccumulatedDepreciationRepayment ofSellinglong-termborrowingsExpenseTotal Cash Flows From Financing ActivitiesNet Property,Plant,General & AdministrativeExpenseEquipmentExpenseNet Increase in TotalCashOperatingand Cash EquivalentsCash and Cash Equivalents,Operating BeginningProfit Note ReceivableCash and Cash Equivalents, EndingInterest Income2,0190(1,021)Stockholders Equity225(664)Stock and0 Common5201,355490 EarningsRetained(1,021)Paid-in CapTotal Shareholders’(886) 1,2351944,0094,203Equity3491,367752481 Total Liabilities andTotal Assets8,374114EquityInterest Expense10Other Income25Pretax Income881Income taxes352Income before Extraordinary Items8,374529Extraordinary Items(132)Net Income397 In this introduction series , we are providing asimple, basic overview of financialstatements and how to analyze them. In thisfirst video, we explain what the incomestatement is and the information that ispresented on it. In the next video, we explainhow to analyze the income statement, and insubsequent videos we cover the balancesheet and cash flow statement. Theinformation presented in these videos is alsoavailable in a free download, which includesdefinitions of most terms mentioned in thesepresentations.1!More Videos and downloads ysis The Kaplan Group!

TheKaplanGroup Introduction to The Income StatementSTATEMENT OF PROFITABILITYThe income statement is the statement ofthe company’s profitability during aspecific period of time. That period oftime may be a month, a quarter, or ayear. Profitability is not the same as cashflow which may be more important forcredit managers assessing the credit riskof a potential customer. Whileprofitability is important, it is not the onlyfactor to consider when evaluating creditrisk. Accounting rules determine howitems should be recorded in the financialstatements but we will not be getting intothe rules in this introductory series.INCOME STATEMENTAt the top of the income statement, the firstthing you will notice is that it tells you whatperiod the information is for, typically amonth, a quarter, or a year. The other keything at the top of the income statement is totell you whether the amounts shown areactual dollars, down to the penny, or whetherthese are truncated numbers. For example,when it says 000’s that means we’ve left offthree zeros. Another way to show that is tohave the word ‘thousands’ or even ‘millions’.So a number that says 11892 and there’snothing here, then that means 11,892. Butin this example, the three zeros indicate thatthe numbers shown are in thousands.Therefore the 11892 stands for 11 million892 thousand dollars. If it said millions then itwould stand for 11 billion, 892 milliondollars—and yes, there are some companieswith numbers that big.Income StatementFor the Year Ended December 31, 2011 (000s)Sales11,892Cost of Goods Sold9,905Gross Profit1,987Research & Development225Selling Expense520General & Administrative ExpenseTotal Operating Expense4901,235Operating Profit752Interest Income114Interest Expense10Other Income25Pretax Income881Income taxes352Income before Extraordinary Items529Extraordinary Items(132)Net Income397 2!More Videos and downloads ysis The Kaplan Group!

TheKaplanGroup Introduction to The Income StatementIncome StatementFor the YearEnded December 31, 2011 (000s)SALES AND GROSSPROFITSales11,892Cost of Goods Sold9,905Gross Profit1,987The first itemto be reportedon the income statement is typically revenue orsales. NextResearch& Development225comes cost of goods sold. This is the direct cost of making the products that were sold togenerateSellingthe revenuereported on the income statement. For example, if thiscompany isExpense520a manufacturer of coffee cups, the cost of goods sold represents the amount of money to& AdministrativeExpense490 Thismake all Generalof the cupsthat werethen soldtoStatementgenerate the 11,892,000 in revenue.Incomewould include theForraw thematerialsand theDecemberlabor that wasto make the cups as wellYearEnded31,required2011 (000s)TotalOperatingExpense1,235as all of the packaging material, but not items like advertising expenses. When yousubtract thecost of goods sold from sales, that gives you what is calledthe gross profit.Sales11,892OperatingProfitThis is a veryimportantnumber because this is the profitability before all of752theoverhead,Costand thehigher thegross profit, the more profitable the businesscan be.of GoodsSold9,905InterestIncomeGross ProfitInterest ExpenseResearch & DevelopmentOther IncomeSelling ExpensePretax IncomeGeneral & Administrative Expense1141,987Incometaxes ExpenseTotal Operating3521,235OPERATING EXPENSESIncome before Extraordinary ItemsOperating Profit1022525520881490529752The next Extraordinarysection of the incomeare theItems statement is the operating expenses. These(132)Interest Income114expenses that the company incurred in order to generate revenue, as well as costsrelated toInterestinvestingExpensefor future sales. Accounting rules require that operating10expensesNetIncome397be divided up into three categories: research and development, selling expense,and OtherIncome overhead. Costs incurred to develop the current25general andadministrativeproductsas well asPretaxnew andpotential future products are recorded in the research 881andIncomedevelopment category, which often is referred to as R&D. Selling expenses includemarketing and advertising costs plus sales people and customer service expenses.General andadministrativeIncometaxes expenses include expenses for departments such352 ashuman resources, legal, and finance. For this company, total operating expenses wereIncomebeforeExtraordinaryItems529 1,235,000.We thensubtractthe operatingexpenses from the gross profit,and thatgives us the operating profit. This is one of the most important items in measuring thecompany's profitability.Extraordinary ItemsMore Videos and downloads atNet analysis(132)3! The Kaplan Group!397

Gross Profit1,987Research & Development225Selling Expense520TheKaplanGroup Introduction to The Income490StatementGeneral & Administrative ExpenseTotal Operating ExpenseOperating ProfitNON-OPERATINGEXPENSESInterest IncomeIncome StatementInterest ExpenseFor the Year Ended December 31, 2011 (000s)Other IncomeSalesPretax IncomeCost of Goods Sold1,235752114102511,8928819,905GrossProfitand expenses are items that effect overall profitability1,987 but aren’tNon-operatingincomeIncometaxes352related to the operations of the business. The easiest example is interest income. Whenthe companyhas extraavailable itItemskeeps it in the bank and it earnsinterest. TheIncomebeforeExtraordinary529Research& moneyDevelopment225amount of interest a company earns has nothing to do with its sales, cost of goods sold,SellingExpense520or operations.Therefore,it is a non-operating item. The same can be saidfor interestExtraordinaryItems(132)expense onGeneralany moneythat the companyhas borrowed. While this is an 490expense, and it& AdministrativeExpensenegatively impacts profitability, it doesn’t have anything to do with operations of thebusiness. NetItTotalhasIncometodo with howthe business was financed. Other incomeis a catch-allOperatingExpense1,235397for all other non-operating income, while temporary changes in the value of assets isalso reflectedin this section.profitOperatingProfit The non-operating income is added to the operating752number to arrive at pretax income. If non-operating income is actually a loss, this willshow as a negative number on the income statement, and when that negative number isInterestIncomeadded to theoperatingprofit, it results a smaller amount shown as pretax114income.Interest ExpenseNET INCOMEOther Income1025Pretax Income881Income taxes352Income before Extraordinary Items529Extraordinary Items(132)Net Income397 In the final section of the income statement, we adjust pretax income for other itemssuch as income taxes and extraordinary items. Accounting rules are very specific onwhat items should be recorded as extraordinary items instead of in operating or nonoperating categories. Net Income is calculated by subtracting income taxes from pretaxincome and adding or subtracting extraordinary items. So in this example, this4!company made 397,000 during the prior year on sales of 11.9 million.More Videos and downloads ysis The Kaplan Group!

TheKaplanGroup Introduction to The Income StatementThe next video in this series is Beginning Income Statement Analysis. Remember,you can download a transcript of this video along with screenshots and definitions tohave as a permanent resource. If you found this information valuable, please Share itor Like it. If you need debt collection assistance, we are specialists in large businessto business claims and we can refer you to other agencies if your needs do not fit withour expertise. Just fill out the Request A Quote form or give us a call.More free videos and downloads on FinancialStatement Analysis are available ore Videos and downloads ysis The Kaplan Group!

Beginning Income Statement AnalysisTheKaplanGroupCommercial Collection AgencySuperior Results Since 1991!www.kgaction.com!805-541-2639More Videos and downloads at The Kaplan analysis The Kaplan Group!

TheKaplanGroup Beginning Income Statement AnalysisIn the prior video, we provided an overview of the income statement. In this video weexplain how to do some simple analysis of the information on an income statement.INCOME STATEMENTWe are using the same income statementfrom the last video, but we have nowadded some line numbers to the left ofeach row. These numbers are there to helpyou understand which items we are usingin our calculations, and how to do thecalculations that end up giving us insightsinto the income statement.Income StatementLine#For the Year Ended December 31, 2011 (000s)1Sales2Cost of Goods Sold11,8929,9053Gross Profit1,9874Research & Development2255Selling Expense5206General & Administrative4907Total Operating Expense1,2358Operating Profit7529Interest Income11410Interest Expense1011Other Income2512Pretax Income88113Income taxes35214Income before Extraordinary Items15Extraordinary Items16Net Income529(132)397GROSS MARGINSince the income statement is a measureof profitability, the first thing we want to dois analyze some of the profitabilitymeasures. The first one is gross profit,which is the profit the company made onsales after cost of goods sold. We aregoing to calculate the gross margin to lookat profitability as a percentage. The grossmargin is calculated by dividing the grossprofit of 1,987,000 by revenue of 11,892,000 and we see that the grossmargin percent is 16.7%. Now whether16.7% is good or bad is something wecan’t tell just yet. We'll discuss how todetermine if this is good or bad in amoment, but first we will define a few otherprofitability ratios.More Videos and downloads ysis1! The Kaplan Group!

TheKaplanGroup Beginning Income Statement AnalysisOPERATING MARGINThe second profitability measure toanalyze on the income statement isoperating profit. We calculate theoperating margin by dividing operatingprofit of 752,000 by total sales of 11,892,000, and that shows that theoperating margin was 6.3%.PRETAX MARGINThe next profitability measure pretaxincome. To calculate the pretax incomemargin, we divide pretax income of 881,000 by sales, of 11,892,000, andwe end up with a pretax margin of 7.4%.2!More Videos and downloads ysis The Kaplan Group!

TheKaplanGroup Beginning Income Statement AnalysisNET PROFIT MARGINThe final margin that we can calculate onthis income statement is the net incomemargin. We divide net income of 397,000 by total sales of 11,892,000and we have a profitability margin of3.3%. This 3.3% profit margin meansthat for every thousand dollars of salesthe company generates a profit of 33.EBIT & EBITDAThere are a couple of other verycommon income statement calculations.One is called EBIT and one is calledEBITDA. EBIT stands for earningsbefore interest and taxes, whichessentially is operating profit. EBITDAstands for earnings before interest,taxes, depreciation, and amortization.We will discuss these items in greaterdetail in our intermediate financialanalysis videos, but we wanted toinclude the definitions and calculationsher for your reference.3!More Videos and downloads ysis The Kaplan Group!

TheKaplanGroup Beginning Income Statement AnalysisQUICK SUMMARY OF THE RATIOSSo here is a quick summary of the ratios we calculated. The gross margin is 16.7%.After taking into account operating expenses, the operating margin is 6.3%. Thepretax margin increases to 7.4% as a result of having some non-operating income.The Net Income margin drops by more than half to 3.3% as a result of taxes andextraordinary items.4!More Videos and downloads ysis The Kaplan Group!

TheKaplanGroup Beginning Income Statement AnalysisGOOD PERFORMANCE?Now that we’ve calculated some ratios, we need to do some analysis. For example, isthe 6.3% operating margin good? Well we need to be able to compare it to somethingto determine if it’s good or not. The first thing you can do is compare it to othercompanies doing the same thing. If other coffee cup manufacturers have anoperating margin of 15% then clearly this company is not doing something right andthe 6.3% is not a good number. However, if other coffee cup manufacturers have anoperating profit margin of 2%, then the 6.3% says this company is doing somethingvery special and very good. We explain how to get information on other companiesin our Intermediate Financial Statement Analysis series.Another way to compare the operating margin is to take a look at how this onecompany has done over time. Is this 6.3% higher than past years (in which case thecompany is becoming more profitable) or is it lower? Typically we want to comparethree years, and sometimes we want to compare quarter to quarter as well as year toyear. Whenever we’re doing this type of comparison, we are looking for trends andmajor changes. So if it’s relatively consistent that’s good, and if it’s improving, that’sbetter. But if there are major changes or it’s going up and down that means you wantto learn more.More Videos and downloads ysis5! The Kaplan Group!

TheKaplanGroup Beginning Income Statement AnalysisINCOME STATEMENT TRENDSSo let’s take a look at the performance of this coffee cup manufacturer over the last threeyears. We can see that sales were 9.1 million in 2009, increasing to 10.5 million in 2010and almost 11.9 million in 2011. That looks really good; sales are going up each year.Now when we look at the change in sales we can see that in 2010 revenue increased by1.37 million and a little more in 2011. So not only is it going up, it’s going up each year.But let’s look at one other item: the sales growth rate. We can see that the 1.37 millionincrease in 2010 represents a 15% growth rate over 2009, but in 2011, even thoughsales went up even more, the growth rate dropped a little bit, down to 13%. In thisexample, the drop in growth rate is not a huge issue. However, you can see that whenyou look at information in different ways you get different insights. While everything maylook good at first, you may actually find that when you look at it from a differentperspective, there issues of potential concern.6!More Videos and downloads ysis The Kaplan Group!

TheKaplanGroup Beginning Income Statement AnalysisGROSS MARGIN TRENDGross Profit Sales!Looking past sales, let’s start looking at actually profitability. The first profitabilitymeasure is gross profit and the related gross margin. And again, we can see that thegross profit is going up each year, from 1.8 million dollars to 1.9 million to almost 2million, which is a good thing. But let’s take a look at the gross margin as a percentageof sales. And in this case, we see that even though total dollar of gross margin wasgoing up each year, the actual percentage, or profitability on sales was going down.Now that could be a key concern. We don’t know why the gross margin is down. Wedon’t know if the company is having to lower prices because of competition, or if theycan’t raise prices as raw material prices go up, or is it an indicator of inefficiency. Eitherway, the declining gross margin percent is of concern. It would be advisable tocompare the gross margin to other coffee cup manufacturers. If everybody else in theindustry has a 10% gross margin, then this company is still doing way better than thecompetition with its 16.7% gross margin, and therefore the decline isn’t as much of aconcern. However, if most companies have a 35% gross margin, then this company isdoing worse than its competition, the trend is negative and this clearly is a big issue ofconcern.7!More Videos and downloads ysis The Kaplan Group!

TheKaplanGroup Beginning Income Statement AnalysisOPERATING MARGIN TRENDOperating Profit Sales!Now let’s take a look at perhaps the

show as a negative number on the income statement, and when that negative number is added to the operating profit, it results a smaller amount shown as pretax income. In the final section of the income statement, we adjust pretax income for other items such as income taxes and extraordinary items. Accounting rules are very specific on

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