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Income Statement; Gross Profit Percent; Inventory Turnover - Accounting video - YouTube
Channel: Dr. Brian Routh
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This is part 5 in our merchandising
operations series, in which we'll be
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talking about income statements and
business evaluations. So the first thing
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we look at is a very simple income
statement. One that you're most familiar with,
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which is called the single step income
statement. And if you look at it, it's a
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simple listing of your revenues and your
expenses, give you net income. Now notice
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in the revenues section there also
including those contra revenues, because
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they are revenues they're just contra
revenues meaning, they effectively reduce
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our net sales revenue. And then from net
sales revenue, we'll subtract our total
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expenses to get net income. Now some
companies will use a more detailed
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income statement called a multi-step
income statement. Now here the revenue
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section is just the same, sales revenue
less the contra accounts gives me net
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sales revenue. From net sales revenue,
we'll actually subtract cost of goods
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sold, because that again as we mentioned
earlier, that's typically a business, a
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businesses largest expense, and
subtracting that from our net sales, we'll
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get what's called gross profit. Gross
profit tells us, okay this is the amount
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that has to cover all of our operating
expenses and any other revenues and
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expenses, and give us the net income or
the profit that we want to have left. So
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from gross profit we'll subtract our
operating expenses, to give us what's
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called operating income. And then from
operating income we'll subtract other
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revenues and expenses, which we've talked
about earlier those are things like
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interest expense, or maybe even interest
revenue, and that will give us our ending
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net income.
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So let's look at some business
evaluation ratios here, the two we're
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going to look at briefly, is the gross
profit percentage and the inventory
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turnover. So let's look at the gross
profit profit percentage first, the gross
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profit percentage is the percent of
sales that's available to cover their
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expenses and provide a profit, this ratio
is closely watched by potential
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investors for any small increases or
decreases. The way we calculate the gross
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profit percentage , is taking our gross
profit which you found in the multi-step
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income statement, and divide that by our
net sales. That will give me my gross
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profit percentage, the second method to
evaluate a business that we're going to
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look at, is inventory turnover. Inventory
turnover will tell someone how rapidly
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this company is selling their inventory,
a higher inventory turnover is more
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desirable, and the higher the inventory
turnover, that typically means there's
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increased profits. To calculate inventory
turnover, the formula is cost of goods
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sold, divided by your average inventory.
So we also have to calculate average
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inventory, so to calculate average
inventory we're going to take our
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beginning inventory, the balance in our
beginning inventory, plus our ending
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inventory, and divide that sum by two.
That will give us our average inventory.
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Divide that into your cost of goods sold,
and that's your inventory turnover. So let's
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look at an example of these two ratios
here, networking systems earn sales
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revenue of 65 million dollars in 2009,
cost of goods sold was 33 million
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dollars, and net income reached 8 million
dollars. The company's highest ever.
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Total current assets included inventory
of three million dollars at December
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31st, 2009. Last year's ending inventory
was four million dollars. The managers of
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networking systems need to know the
company's gross profit percentage and
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rate of inventory turnover for 2009.
Compute these needed amounts. So let's
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start with gross profit percent, remember
our formula is gross profit divided by
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net sales. So the first thing we have to
recall is, how do we calculate gross
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profit? Well remember gross profit is
your sales revenue, less any contour
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revenue accounts, gives me my net sales.
So there's the net sales formula, from net
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sales we subtract cost of goods sold, and
that gave me gross profit. So the first
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thing we have to do is find our sales
revenue, they tell us that was 65 million
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dollars, in the first line of the problem.
They did not mention any contour revenue
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accounts in the story. So we assume there aren't any, so sales revenue is the same
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thing as net sales. 65 million dollars,
from that we need to subtract our cost
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of goods sold, which they tell me in line
two is 33 million dollars, and divide
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that by my net sales of the 65 million.
That will give me a gross profit
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percentage of 49.2 percent, what that's
telling me is 49.2 percent of my net
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sales will become gross profit. That
means about 51 percent of my net sales
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is actually going to cover cost of goods
sold, depending on the industry of the
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business it could be good or bad. Again
we can't immediately say this is bad or
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this is good, without doing a little bit
more research into the industry of
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networking systems. Now let's take a look at inventory turnover, remember inventory
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turnover is your cost of goods sold
divided by your average
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inventory. We already know cost of goods sold, we've looked at that earlier. It is 33
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million dollars, but now we need average
inventory. Remember the formula for
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average inventory, is your beginning
inventory, plus your ending inventory,
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divided by two. Well they tell me that my
ending inventory is three million
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dollars, but they also tell me that last
year's ending was four million dollars.
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We'll recall that the prior years ending,
is this year's beginning. So our
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beginning inventory would be four
million dollars, plus our ending of three
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million dollars, seven million dollars,
divided by two is 3.5 million. Divide
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that into your 33 million of cost of
goods sold, and that gives you an
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inventory turnover of nine point four
three times. So what that means is we
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completely turn over our inventory,
almost nine and a half times this year.
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