Income statement

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Financial Awareness
Income Statement
Aqhuman financial training & coaching

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The Income Statement
Let us build a format:
Revenue (sales, turnover) 500
Cost of sales (100)
Gross profit 400
Operating costs (100)
Operating profit 300

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Cost of sales (100)
Gross profit 400
Recall that we speak
of “above the line”;
this represents the
operational activities
of the business

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Cost of sales (100)
Gross profit 400
Interest ( 50)
Profit before tax 250
Taxation ( 75)
Profit attributable to shareholders 175
Below the line refers to
“treasury” matters;
dealing with tax
planning and financing.
The International
income statement
finishes here:

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Cost of sales (100)
Gross profit 400
Interest ( 50)
Taxation ( 75)
Profit attributable to shareholders 175
Dividends (100)
Retained earnings 75
Whereas the UK gaap
profit and loss account
continues to show the
dividend. Under IAS this
information is shown in
the notes.

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Revenue recognition (or when is a sale a
sale?)
Above is a flight booking transaction. When does the airline count this as a sale
(that is, recognise the sale in its income statement)?
10 Feb: booked 10 March: paid 30 March: year
end
10 April: tickets
arrive
10 May: fly

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Revenue recognition (or when is a sale a
sale?)
Above is a flight booking transaction. When does the airline count this as a sale (that
is, recognise the sale in its income statement)?
When the flight is taken; a sale is a sale when the goods or services are delivered.
Note: it does NOT follow the cash, that is why we have a separate cash flow
statement.
10 Feb: booked 10 March: paid 30 March: year
end
10 April: tickets
arrive
10 May: fly
x

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Revenue recognition
So it is important to get the sale
in the right year as the costs
go in the same year. Sales in
the wrong year + costs in the wrong
Year = profit in the wrong year!

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Revenue recognition: another example
A landlord collects the rent quarterly in advance; £100,000 on 24th
March 2011. His year end is the 31st March 2011. How much rent goes in
the income statement for the year end 31 March 2011?

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Revenue recognition: another example
A landlord collects the rent quarterly in advance; £100,000 on 24th March
2011 . His year end is the 31st March 2011. How much rent goes in the
income statement for the year end 31 March 2011?
7 days worth (say £8,000). The cash flow for that
year is £100,000; the amount received.
The remaining £92,000 is shown on the balance sheet
as a liability (“deferred income”); the tenant has paid
for something they have yet to receive.

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Costs
Cost of sales (100)
Gross profit 400
What is the difference
between these two
types of cost?

Costs
A cost of sale is closely associated with the company’s product,
for example...
raw material, production labour,
factory costs

Costs
A cost of sale is closely associated with the company’s
product, for example...
raw material, production labour,
factory costs
Whereas operating costs are more remote,
such as...
human resources, accounting, legal, IT

Cost of sales and the matching principle
A retailer buys 100 tins of beans at £1 a tin. In the year he
sells 20 for £3 a tin each. What is his profit?
Sales (20 x £3) 60
Cost of sales (20 x £1) (20)
Profit 40

Cost of sales and the matching principle
A retailer buys 100 tins of beans at £1 a tin. In the year he
sells 20 for £3 a tin each. What is his profit?
Sales (20 x £3) 60
Cost of sales (20 x £1) (20)
Profit 40
We have sold 20 so we only bring in the cost of 20. This is the
matching principle.
Note that the retailer’s cash flow is £100 but the p&l cost is
only £20

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Costs and assets
Recall that the retailer spent (cash)
Of this £20 was taken as a cost to
the income statement
What does the remaining represent?
£100
(£20)
£80

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Costs and assets
Recall that the retailer spent (cash)
Of this £20 was taken as a cost to
the income statement
What does the remaining represent?
This is, of course, stock (or inventory)
and will appear as an asset on the balance sheet
£100
(£20)
£80

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Cost and assets
Cash expenditure £100
£20 cost £80 asset
income statement balance sheet
Costs are expenditure where the benefit has been received (the retailer
bought the tins in order to sell them; 20 have been sold, so there is no
further benefit to come from those).

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Cost and assets
Cash expenditure £100
£20 cost £80 asset
income statement balance sheet
Costs are expenditure where the benefit has been received (the
retailer bought the tins in order to sell them; 20 have been sold, so there
is no further benefit to come from those).
Assetsrepresent expenditure where the benefit is yet to come (there
are 80 unsold tins; the benefit will arise when the retailer sells them)

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Depreciation
You buy some equipment, today, for £10,000. You estimate
that it has a 5 year life, when you will scrap it.
Balance 10
sheet
Income
statement
Cash flow (10)
Today
Today; all of the benefit of
owning the equipment lies
in the future. So the
expenditure is entirely an
asset

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Depreciation
Balance 10 10
Sheet (2)
8
Income
Statement (2)
Cash flow (10)
Today
A year later 1/5th of the
expected benefit has been
used; so 1/5th of the spend
is now a cost. This is
depreciation
1

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Depreciation
Balance 10 10
Sheet (2)
8
Income
Statement (2)
Cash flow (10)
Today 1 2
10 10 10 10
(4) (6) (8) (10)
6 4 2 -
(2) (2) (2) (2)
3 4 5

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Dividend policy
What factors do the directors of a business use to decide the
level of dividends?

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Dividend policy
What factors do the directors of a business use to decide the
level of dividends?
Investment for growth (and therefore
the maturity of the business)
Has the company made a profit?
Does it have the cash to make the payment?
What dividend yields are the shareholders expecting?
Does it need to reduce gearing?

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Retained earnings (or profits)
Cost of sales (100)
Gross profit 400
Interest ( 50)
Taxation ( 75)
Profit attributable to shareholder 175
Dividends (100)
These profits
here belong
to the
shareholders

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Cost of sales (100)
Gross profit 400
Interest ( 50)
Taxation ( 75)
Dividends (100)
The dividends
represent the
amount that the
shareholders
withdraw

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Cost of sales (100)
Gross profit 400
Interest ( 50)
Taxation ( 75)
Dividends (100)
Which leaves the retained
earnings; the shareholders’
profits that they choose to
leave behind in the business.
By leaving the profits behind
they have increased their
investment, or equity

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Income statement; summary
•Sales are sales when the goods or service are delivered
•Costs represent expenditure where the benefit has been
received (for example cost of sales where the sale has been
made)
•Profit does not follow the cash (hence profitable companies
fail all the time; insolvency is entirely a cash matter)
•Dividends decisions are driven by cash flow and
shareholder expectations

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Aqhuman Financial Training
Aqhuman’s principal is Kevin Amor, FCA. Kevin qualified as a
chartered accountant with PWC. He spent 12 years working
in commerce at financial controller/director level.
Kevin now has more than 12 years experience in financial
training. He trains managers at all levels and gives 1 to 1
financial coaching to senior executives.
He also teaches corporate finance and
accounting for a number of business
schools’ MBA programmes.

Income statement

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