profitability

Examples of profitability in the following topics:

• Cost of Goods Sold and Gross Profit

  • Gross profit or sales profit is the difference between revenue and the cost of making a product or providing a service.
  • In accounting, gross profit or sales profit is the difference between revenue and the cost of making a product or providing a service before deducting overhead, payroll, taxation, and interest payments.
  • Note that this is different from operating profit (earnings before interest and taxes).
  • Net income (or Net profit) = Operating profit – taxes – interest
  • Explain the difference between cost of goods sold and gross profit

• Gross Profit Method

  • The gross profit method uses the previous year's average gross profit margin to calculate the value of the inventory.
  • Keep in mind the gross profit method assumes that gross profit ratio remains stable during the period.
  • Determine the gross profit ratio.
  • Gross profit ratio equals gross profit divided by sales.
  • Use projected gross profit ratio or historical gross profit ratio whichever is more accurate and reliable.

• Income Statement Formats

  • An income statements may also be referred to as a profit and loss statement (P&L), revenue statement, statement of financial performance, earnings statement, operating statement or statement of operations.
  • A company's financial statement indicates how the revenue, money received from the sale of products and services before expenses are taken out, is transformed into the net income, the result after all revenues and expenses have been accounted for, also known as Net Profit.
  • In the multiple-step format revenues are often presented in great detail, cost of goods sold is subtracted to show gross profit, operating expenses are separated from other expenses, and operating income is separated from other income.
  • The income statement is used to assess profitability, as the expenses for the period are deducted from the revenues.
  • When net income is positive, it is a called profit.

• Expense Recognition

  • Expense recognition is an essential element in accounting because it helps define how profitable a business is in an accounting period.
  • The expenditure offsets the income the business earned and is used to calculate the business's profit.
  • By shifting the timing of when expenses are recognized, a company can artificially make its business appear more profitable.

• Assessing Control

  • The profit or loss of the investor includes the investor's share of the profit or loss of the investee.
  • Under the equity method, the investment in an associate is initially recognized at cost and the carrying amount is increased or decreased to recognize the investor's share of the profit or loss of the investee after the date of acquisition.
  • The investor's share of the profit or loss of the investee is recognized in the investor's profit or loss.
  • The investor shall recognize in profit or loss any difference between:
  • The investor's share of the profit or loss of the investee is recognised in the investor's profit or loss.

• Importance of Cash Flow Accounting

  • Being profitable does not necessarily mean being liquid.
  • A company can fail because of a shortage of cash even when it is profitable.
  • Cash flow is often used as an alternative measure of a company's profitability when it is believed that accrual accounting concepts do not represent economic realities.
  • For example, a company may be profitable but generate little operational cash (as may be the case for a company that barters its products rather than selling for cash or when its accounts receivable turnover is long).

• Impact of Inventory Method on Financial Statement Analysis

  • The inventory method chosen will affect the amount of current assets and gross profit income statement, especially when prices are changing.
  • Under FIFO: Ending Inventory is higher, and Total Current Assets are higher; cost of goods sold is lower, and gross profit is higher.
  • Under LIFO: Ending Inventory is lower, and total current assets are lower; cost of goods sold is higher, and gross profit is lower.
  • Under FIFO: Ending Inventory is lower, and total current assets are lower; cost of goods sold is higher, and gross profit is lower.
  • Under LIFO: Ending Inventory is higher, and total current assets are higher; cost of goods sold is lower, and gross profit is higher.

• Dividends Payable

  • Dividends are the portion of corporate profits paid out to shareholders.
  • When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be distributed to shareholders as dividends.
  • For the company, a dividend payment is not an expense, but the division of after tax profits among shareholders.

• Working Capital Management Analysis

  • A company can be endowed with assets and profitability but short on liquidity if its assets cannot be converted into cash .
  • Working capital management entails short-term decisions, usually relating to the next one-year period and are based in part on cash flows and/or profitability.
  • Profitability can be evaluated by looking at return on capital (ROC).
  • When ROC exceeds the cost of capital, firm value is enhanced and profits are expected in the short term.

• Relationships Between Statements

  • Each statement has a specific purpose; the income statement reflects a company's profitability, while the statement of retained earnings shows the change in retained earnings between the beginning and end of a period (e.g., a month or a year).
  • Together these four statements show the profitability and strength of a company.
  • The income statement reports the profitability of a business by comparing the revenues earned with the expenses incurred to produce these revenues.