purpose of an income statement by bizdox

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									The Income Statement
    & Its Analysis
       (Chapter 6)




                       1
              Objectives
1. Discuss the purpose of an income statement.
2. Illustrate the structure and format of an
   income statement.
3. Define the sources and types of revenue and
   expenses included on an income statement.
4. Show how profit, or net farm income, is
   computed.
5. Analyze farm profitability by computing
   different measures of profitability.


                                                 2
  The Income Statement
• A summary of revenue and expenses for
  a given accounting period:
  – Operating statement.
  – Profit or loss statement.
• Purpose: to measure the difference
  between revenue and expenses:
  – A positive difference indicates a profit.
  – A negative difference indicates a loss.


                                                3
   Balance Sheet and Income
    Statement Relationship
Balance sheet                                 Balance sheet
 prepared                                      prepared
                Accounting period of 1 year

  Jan. 1                                        Dec. 31

                    Income statement

       Income, expenses, and profit for the period

                                                          4
                Revenue
• Include all business revenue earned during the
  accounting period but no other revenue.
• The problem: determining what accounting
  period the revenue was earned in:
   – Revenue can be cash or non-cash.
• Revenue should be recognized whenever a
  commodity is ready for sale:
   – Inventories of grain and market livestock.
• Accounts receivable represent revenue.
• Commodities received in lieu of cash are
  revenue.
                                                   5
           Gain or Loss
      on Sale of Capital Assets
• The difference between the sale price and the cost of a
  capital asset such as land.
• The difference between the selling price and the book
  value for depreciable assets:
   – In both cases, recognized only when an asset is sold.
   – Both are listed separately on income statement with
     some exceptions.
• Non-depreciable asset - A gain or loss on the sale is the
  result of an increase or decrease in the market price.
• Depreciable asset – A gain or loss can be a result of
  changes in the market value or accuracy of your
  depreciation estimate.
                                                              6
          Gain or Loss
     on Sale of Capital Assets
• If a depreciable asset is sold for:
  – Exactly the book value, then no gain or loss:
     • Depreciation perfectly matched market value.
  – A price higher than book value then a gain:
     • Too much depreciation has been taken.
  – A price less than book value then a loss:
     • Not enough depreciation has been taken.
• Such gains or losses usually recognized
  separately.
                                                      7
              Expenses
• Cash Expenses:
  – Purchases of and payment for feed,
    fertilizer, seed, market livestock, fuel.
• Non-cash Expenses:
  – Depreciation, accounts payable, accrued
    interest, other accrued expenses.



                                                8
Income Statement Format
            (Accrual Basis)

Total revenue
Less total expenses
Equals net farm income from operations
Plus or minus gain/loss on sale of capital
  assets
Equals net farm income


                                             9
         Income Statement Format
                           (Revenue Details)

                                Revenue
Cash crop sales                                $ xxx
Cash livestock sales                             xxx
Inventory changes:
 Crops                                          xxx
 Market livestock                               xxx
Livestock product sales                         xxx
Government program payments                     xxx
Change in value of raised breeding livestock    xxx    exception
Gain/loss from sale of breeding livestock       xxx    mentioned earlier
Change in accounts receivable                   xxx
Other farm Income                               xxx
 TOTAL REVENUE                                               $ XXX 10
         Income Statement Format
                          (Expense Details)

                                 Expenses
Purchased feed and grain                    $ xxx
Purchased market livestock                    xxx
Other cash operating expenses:
 Crop expenses                               xxx
 Livestock expenses                          xxx
 Fuel, oil                                   xxx
 Labor                                       xxx
 Repairs, maintenance                        xxx
 Property taxes                              xxx
 Insurance                                   xxx
 Other:
   ________                                  xxx    11
(continued)
         Income Statement Format
                 (Expense Details - continued)

                              Expenses
Adjustments:
 Accounts payable                        xxx
 Prepaid expenses                        xxx
Depreciation                             xxx
 Total Operating Expense                         XXX
Cash interest expense                    xxx
Change in interest payable               xxx
 Total interest expense                          XXX
 Total Expenses                                  XXX

Net farm income from operations                  XXX
 (Total Revenue minus Total Expenses)                  12
         Income Statement Format
                      (Capital Gains/Losses)
Gain/Loss on sale of capital assets:
 Machinery                             xxx
 Land                                  xxx
 Other
  ____________                         xxx
 Total Gain/Loss from capital assets           XXX
 NET FARM INCOME                               $XXX
(Net Farm Income from operations
 plus or minus Total Gain/Loss on
 capital assets)


                                                      13
14
           Cash Income Statement
            (Revenue Accrual Adjustments)
              - Beginning Inventory
Cash          + Ending Inventories     Gross
Receipts                              Revenue




                                                15
           Cash Income Statement
            (Revenue Accrual Adjustments)
              - Beginning Inventory
Cash          + Ending Inventories              Gross
Receipts      - Beginning Accounts Receivable   Revenue
              + Ending Accounts Receivable




                                                          16
            Cash Income Statement
                (Expense Accrual Adjustments)
                    - Beginning Accounts Payable
                    + Ending Accounts Payable



   Cash                                                             Operating
Disbursements                                                       Expense




Notes: Depreciation is included in the cash income statement, so no adjustment.
       Avoid double counting items included in prepaid expenses and unused
        supplies when assessing investment in growing crops.               17
            Cash Income Statement
                (Expense Accrual Adjustments)
                    - Beginning Accounts Payable
                    + Ending Accounts Payable
                    - Beginning Accrued Expenses
                    + Ending Accrued Expenses
   Cash                                                             Operating
Disbursements                                                       Expense




Notes: Depreciation is included in the cash income statement, so no adjustment.
       Avoid double counting items included in prepaid expenses and unused
        supplies when assessing investment in growing crops.               18
            Cash Income Statement
                (Expense Accrual Adjustments)
                    - Beginning Accounts Payable
                    + Ending Accounts Payable
                    - Beginning Accrued Expenses
                    + Ending Accrued Expenses
   Cash              + Beginning Prepaid Expenses                   Operating
Disbursements       - Ending Prepaid Expenses                       Expense




Notes: Depreciation is included in the cash income statement, so no adjustment.
       Avoid double counting items included in prepaid expenses and unused
        supplies when assessing investment in growing crops.               19
            Cash Income Statement
                (Expense Accrual Adjustments)
                    - Beginning Accounts Payable
                    + Ending Accounts Payable
                    - Beginning Accrued Expenses
                    + Ending Accrued Expenses
   Cash              + Beginning Prepaid Expenses                   Operating
Disbursements       - Ending Prepaid Expenses                       Expense
                    + Beginning Unused Supplies
                     - Ending Unused Supplies



Notes: Depreciation is included in the cash income statement, so no adjustment.
       Avoid double counting items included in prepaid expenses and unused
        supplies when assessing investment in growing crops.               20
            Cash Income Statement
               (Expense Accrual Adjustments)
                    - Beginning Accounts Payable
                    + Ending Accounts Payable
                    - Beginning Accrued Expenses
                    + Ending Accrued Expenses
   Cash              + Beginning Prepaid Expenses                    Operating
Disbursements       - Ending Prepaid Expenses                         Expense
                    + Beginning Unused Supplies
                     - Ending Unused Supplies
                     + Beginning Investment in Growing Crops
                      - Ending Investment in Growing Crops
Notes: Depreciation is included in the cash income statement, so no adjustment.
       Avoid double counting items included in prepaid expenses and unused
        supplies when assessing investment in growing crops.               21
       Cash Income Statement
                (Accrual Adjusted)

  Cash Receipts               Gross Revenue
- Cash Disbursements        - Operating Expenses
- Depreciation              - Depreciation
= Cash Net Income           = Accrual Adjusted
   (pre-tax)                 Net Income (pre-tax)




                                              22
               Profitability
• Based on the income statement:
   – Accrual or cash??
• Measures efficiency in using resources to
  produce profit.
• “Profitability” is a relative measure and several
  factors influence whether acceptable or not:
   – What you are trying to accomplish (goals??).
   – Size of the business.
   – What is acceptable to others:
      • Investors, family members, other owners, etc.

                                                        23
Analysis of Farm Profitability
1.   Net Farm Income
2.   Rate of Return on Farm Assets
3.   Rate of Return on Farm Equity
4.   Operating Profit Margin Ratio




                                     24
   Measures of Profitability
Net Farm Income
1. Matches revenues with expenses incurred to
    create those revenues + gain or loss on sale of
    capital assets.
2. Think of as dollar return to equity capital,
    unpaid labor, and management.
3. Net Farm Income Goal:
   - Estimate income that owner’s labor, management,
       and capital could earn in non-farm uses.


                                                       25
      Measures of Profitability
Rate of Return on Farm Assets:
   Net farm income from operations
+ Farm interest expense
– Return to unpaid labor and management.
   (owner withdrawals, opportunity cost)
------------------------------------------------------
= $ Return to assets
%Rate of return on assets:
($ Return to assets ÷ Average total farm assets) x 100
 where:
 average assets = (beginning assets + ending assets)/2
                                                         26
     Measures of Profitability
Rate of Return on Farm Assets (example)

       Net farm income from operations                 +46,800
       Farm interest expense                           +29,500
       Opportunity cost for unpaid labor and mngt.     – 25,000
            Return to Assets                           $51,300

       51,300 ÷ ([710,000 + 741,500] ÷ 2) = 0.0707
       Multiply by 100

• Write the Rate of Return on Farm Assets as 7.07%
   – Return to debt and equity capital.
   – Compare to: similar operations, other investments, opportunity
     cost of capital, past rates.
   – Cost valuation – checking trends within the business.
   – Market valuation – comparison purposes.
                                                                  27
   Measures of Profitability
Rate of Return on Farm Equity:
  Net farm income from operations
– Return to unpaid labor and mngt.
   (owner withdrawals, opportunity cost)
-----------------------------------------------------
 = Return to equity

%Rate of return on equity:
($ Return on equity ÷ Average farm equity) x 100
   where:
average equity = (beginning equity+ ending equity)/2
                                                        28
    Measures of Profitability
Rate of Return on Farm Equity (example):

        Net farm income from operations               +46,800
        Opportunity cost for unpaid labor and mngt.   – 25,000
             Return to Equity                         $21,800

        21,800 ÷ ([350,600 + 372,640] ÷ 2) = 0.0603
        Multiply by 100

•   Write the Rate of Return on Farm Equity as 6.03%
•   Return on owner’s share of capital invested.
•   Cost valuation – checking trends within the business.
•   Market valuation – comparison purposes.

                                                                 29
 Comparing ROA and ROE
ROA = 7.07%
ROE = 6.03%
What are implications of this?
If ROA > borrowed i, then ROE > ROA
If ROA < borrowed i, then ROE < ROA
What does this tell you:
Borrow money when ROA < i ??
Borrow money when ROA > i ??
Recall leverage idea we talked about earlier?

                                                30
     Measures of Profitability
Operating Profit Margin Ratio:

   Net farm income from operations
+ Farm interest expense
– Return to unpaid labor and mngt.
   (owner withdrawals, opportunity cost)
------------------------------------------------------
= Operating Profit

Operating profit margin ratio:
($ Operating Profit ÷ Total Revenue) x 100
                                                         31
      Measures of Profitability
Operating Profit Margin Ratio (example):
        Net farm income from operations               +46,800
        Farm interest expense                         +29,500
        Opportunity cost for unpaid labor and mngt.   – 25,000
             Operating Profit                         $51,300

        51,300 ÷ 200,400 = 0.2560
        Multiply by 100

•   Write the Operating Profit Margin Ratio as 25.60%
•   Operating profit as % of total revenue.
•   Higher values mean more profit per dollar of revenue.
•   Make sense to expand revenue if low profit margin?
                                                                 32
Change in Owner Equity
Net farm income must end up in one of
   four uses:
     1.   Owner withdrawals for family living expenses.
     2.   Payment of income and social security taxes.
     3.   Increase in cash or other farm assets.
     4.   Reduction in liabilities through principal
          payments on loans or payment of other
          liabilities.
What remains is retained farm earnings.

                                                      33
 Net Farm Income
& Change in Equity




                     34
                    Summary
•       An income statement organizes revenue and
        expenses for an accounting period and
        computes net farm income.
•       Profitability refers to the size of the profit
        relative to the resources used to generate it.
•       Measures of profitability include:
    –     Net Farm Income
    –     Rate of Return on Farm Assets
    –     Rate of Return on Farm Equity
    –     Operating Profit Margin Ratio
•       Retained farm earnings is what income
        remains after family living expenses, taxes,
        and other withdrawals.
                                                         35

								
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