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Lecture 3
INCOME STATEMENT
ANALYSIS
Prof. dr. Anamaria CIOBANU
The Income Statement
The income statement provides us with
information about the firms revenues and
expenses over some previous time period
(usually quarterly, semiannually, and annually)
The Income Statement
The income statement presents in a summary
form the profitability of a firm over an annual
period
The income statement equation:
Revenue – Expenses = Income
A positive difference indicates a profit.
A negative difference indicates a loss.
The Income Statement and the
Accrual Accounting
The revenues and expenses are reported based
on the principles of accrual accounting: there are
recognized as they are incurred rather than
when the cash is received or paid out
the net income will not reflect the cash
generated by the company
What is the connection between income
statement and the balance sheet?
ANGLO-SAXON APPROACH
Sales revenue
- Cost of goods sold
- Selling, general and administrative expenses
= Operating Income
+ Other revenues
-Other expenses (Except Interest)
= EBIT
- Interest payment
= EBT
- Taxes
= Net Income
ROMANIAN APPROACH
Operating revenues
- Operating expenses
= Operating income Operating Income
+ Financial Income
Financial revenues + Extraordinary Income
- Financial expenses = EBT
= Financial income - Corporate Income Tax
= Net Income
Extraordinary revenues
- Extraordinary expenses
= Extraordinary Income
How is the net income of each company obtained?
In which one should you invest?
Income statement and profit margin
French approach
Commercial margin
Value added
Operating margin
Current margin
Net margin
Income statement and profit margin
Anglo-Saxon approach
Gross margin
EBITDA
EBIT
EBT
Net income
Operating Breakeven Analysis
An analytical technique for studying the
relationship between sales revenues, operating
costs, and profits.
Operating Breakeven Analysis
First of all you have to identify the company’s:
Operating fixed costs (F) :
depreciation & amortization ;
rents ;
general administrative expenses ;
executive’s salaries ;
Operating variable costs (VC) :
raw materials costs;
costs of direct labor;
Breakeven Point Computation
Sales Total operating Total Total
revenues costs variable costs fixed costs =
= +
(p x Q) = TOC = (v x Q) + F
QOpBE F
p-v =
SOpBE F
= 1-
v
p ( )
Operating Breakeven Analysis
- example -
Sales (S)--(110 million units) 1,650.00$
Variable cost of goods sold (VC) (1,353.00)
Gross profit (GP) 297.00
Fixed operating costs (F) (154.00)
Net operating income (NOI = EBIT) 143.00$
Breakeven Point Computation
- example -
QOpBE $154.0 million
$15.00 - $12.30 = =
$154.0 million $2.70
57.04 million units 57.0 million units
=
Breakeven Point Computation
- example -
For the proposal to break even, Unilate must
sell 57 million units or $855,600,000 of product.
SOpBE $154.0
$12.30
$15.00
= = $154.0 1 - 0.82
1-
= $154.0 0.18 ( )
= 855.6 million
Operating Breakeven Point Chart
0 20 40 57 60 80 100 120
1,400
1,200
1,000
600
400
0
Units QOpBE
Revenues
& Costs
Total Fixed Costs (F)
Total Operating
Costs (F + Q x v)
Total Sales Revenues (p x Q)
SOpBE =
200 154
856 800
Operating Breakeven
Point (EBIT = 0)
Operating Profit
(EBIT > 0)
Operating Loss
(EBIT < 0)
The Usefulness of Breakeven Point
Analysis
estimates the sales needed to cover the
cost of production;
necessary in order to decide the company
expansion;
useful when the management have to
decide the start of a new investment.
The Limits of Breakeven Point
Analysis
the analysis assumes the selling price is
constant;
unit variable costs are assumed to be constant;
this analysis assumes fixed costs are the same
over time;
Degree of Operating Leverage
The percentage change in EBIT associated
with a given percentage change in sales.
Each 1 percent change in sales, will result in a
x percent change in EBIT.
Calculating the Degree of Operating
Leverage
xSalesSales
Sales
Sales
Sales
EBIT
EBIT
LOPBE0
0
0
0o
The Degree of Operating Leverage
- example -
Sales
(mil. $)
Sales
(mil. $)
Sales
(%)
EBIT
(mil. $)
EBIT
(mil. $)
EBIT
(%)
Lo
1200 -400
1500 300 25,0 -250 150 -37,5 -1,5
2000 500 33,3 0 250 -100 -3,00
3000 1000 50 500 500 Can’t be
calculated
4900 1900 63,3 1450 950 190 3,00
8800 3900 79,6 3400 1950 134,5% 1,69
17600 8800 100,0 7800 4400 129,4 1,29
Quick Quiz
Which is the most suitable income margin to be used when we compare the
companies’ profitability on a same activity sector?
Which are the usefulness of the Operating Breakeven Analysis and its
limits?
If the structure of company’s expenses is modified how will be changed the
level of sales at break even point?
What is the meaning of calculating the Degree of Operating Leverage?
An increase of company’s fixed costs will lead to a decrease or increase of
its Degree of Operating Leverage?
What will be the impact of one company’s activities outsourcing on its
breakeven point?