6.6 Describe and Prepare Multi-Step and Simple Income Statements for Merchandising Companies
Income statements for merchandising companies reveal crucial financial information. These statements come in two formats: multi-step and simple. Each type breaks down sales, costs, and expenses differently, giving insights into a company's profitability and operational efficiency.
Understanding these statements is key for assessing a company's financial health. The gross profit margin ratio, calculated from these statements, is a vital metric. It shows how well a company manages its inventory and pricing, helping investors and managers make informed decisions about the business's performance.
Multi-Step and Simple Income Statements for Merchandising Companies
Multi-step income statement preparation
- Revenues
- Sales
- Gross sales: total sales before any deductions (returns, allowances, discounts)
- Less: Sales returns and allowances: merchandise returned by customers or price reductions granted
- Less: Sales discounts: price reductions offered for early payment
- Beginning inventory: value of merchandise on hand at the start of the period
- Add: Purchases
- Gross purchases: total cost of merchandise bought during the period
- Less: Purchase returns and allowances: cost of merchandise returned to suppliers or price reductions received
- Less: Purchase discounts: price reductions received for early payment to suppliers
- Selling expenses: costs directly related to selling merchandise (sales salaries, advertising, depreciation of sales equipment)
- General and administrative expenses: costs related to overall business operations (office salaries, utilities, depreciation of office equipment)
- Other revenues and gains: income from sources not related to core business operations (interest income, gain on sale of assets)
- Other expenses and losses: expenses not related to core business operations (interest expense, loss on sale of assets)
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Simple income statement creation
- Net sales
- Gross sales: total sales before any deductions (returns, allowances, discounts)
- Less: Sales returns and allowances: merchandise returned by customers or price reductions granted
- Less: Sales discounts: price reductions offered for early payment
- Beginning inventory: value of merchandise on hand at the start of the period
- Add: Net purchases
- Gross purchases: total cost of merchandise bought during the period
- Less: Purchase returns and allowances: cost of merchandise returned to suppliers or price reductions received
- Less: Purchase discounts: price reductions received for early payment to suppliers
- Selling expenses: costs directly related to selling merchandise (sales salaries, advertising, depreciation of sales equipment)
- General and administrative expenses: costs related to overall business operations (office salaries, utilities, depreciation of office equipment)
Gross profit margin ratio analysis
- Gross profit margin ratio = (Gross profit ÷ Net sales) × 100
- Measures the percentage of each sales dollar remaining after deducting the cost of goods sold
- Example: if gross profit is 100 , 000 a n d n e t s a l e s a r e 100,000 and net sales are 100 , 000 an d n e t s a l es a re 500,000, the gross profit margin ratio is ( 100 , 000 ÷ 100,000 ÷ 100 , 000 ÷ 500,000) × 100 = 20%
- Company is more efficient at generating profit from sales (able to sell merchandise at a higher markup)
- Company has better control over its cost of goods sold (able to purchase merchandise at lower costs or manage inventory effectively)
- Company may have higher pricing power in the market (able to charge higher prices due to strong brand, unique products, or limited competition)
- Company is less efficient at generating profit from sales (may need to lower prices to remain competitive)
- Company has less control over its cost of goods sold (may face higher costs from suppliers or inefficient inventory management)
- Company may face increased competition or pressure to lower prices (due to market saturation, substitute products, or price-sensitive customers)
- Compare the company's ratio to its historical performance to identify trends (improving or deteriorating profitability over time)
- Compare the company's ratio to industry averages or competitors to assess relative performance (whether the company is outperforming or underperforming its peers)
- Changes in selling prices (increasing prices can improve the ratio, while decreasing prices can worsen it)
- Changes in cost of goods sold (lower costs can improve the ratio, while higher costs can worsen it)
- Changes in product mix (sales of high-margin vs. low-margin products)
- Example: if a company shifts its sales mix towards higher-margin products (luxury goods), the gross profit margin ratio may improve
- Example: if a company can increase its sales volume without proportionally increasing its cost of goods sold (bulk purchasing discounts), the gross profit margin ratio may improve
Inventory Systems and Accounting Methods
- Periodic inventory system: inventory is updated at specific intervals, typically at the end of an accounting period
- Perpetual inventory system: inventory is continuously updated as transactions occur, providing real-time inventory information
- Accrual basis accounting: revenue and expenses are recorded when earned or incurred, regardless of when cash is received or paid, which affects the timing of recognizing merchandising operations
