Analyzing an Income Statement
Elf Corporation experienced a decrease in sales, cost of goods sold, gross profit, interest expense, and tax expense while it experienced an increase in operating expense namely advertising and marketing. The company, however, had a constant gross profit margin of 50% for the three years. This is a high margin and it shows the entity’s ability to mark up sales above the cost of goods sold. Elf Corporation has a profit to cost of goods ratio of 1:1. The company, therefore, makes $1 for every dollar incurred in cost of sales. Nevertheless, upon a closer look, the firm has a decreasing pretax profit margin, operating margin, and net profit margin. These show that while the firm is generating high profits, expenses are also increasing as a proportion of sales. These are operating, interest, and tax expenses.
| Normal Income Statement | Common Size Income Statement | |||||
| (in millions) | 2010 | 2009 | 2008 | 2010 | 2009 | 2008 |
| Sales | $700 | $650 | $550 | 100.00% | 100.00% | 100.00% |
| Cost of goods sold | 350 | 325 | 275 | 50.00% | 50.00% | 50.00% |
| Gross profit | 350 | 325 | 275 | 50.00% | 50.00% | 50.00% |
| Operating Expenses: | ||||||
| Administrative | 100 | 100 | 100 | 14.29% | 15.38% | 18.18% |
| Advertising and marketing | 50 | 75 | 75 | 7.14% | 11.54% | 13.64% |
| Operating profit | $200 | $150 | $100 | 28.57% | 23.08% | 18.18% |
| Interest expense | 70 | 50 | 30 | 10.00% | 7.69% | 5.45% |
| Earnings before tax | $130 | $100 | $ 70 | 18.57% | 15.38% | 12.73% |
| Tax expense (50%) | 65 | 50 | 35 | 9.29% | 7.69% | 6.36% |
| Net income | $ 65 | $ 50 | $ 35 | 9.29% | 7.69% | 6.36% |
What conclusions can you draw from the different parts of the statement?
A common-sized income statement makes it easy to see which item is driving profits and compare it with its peers in other years (). The corporation’s Cost of goods sold is very high at 50%. The operating expenses are increasing as a proportion of sales. The reasons being the increase in advertising and marketing and the reduction in sales while administrative expenses remain constant. The company’s interest and tax expenses are both reducing as a proportion of sales. The reason for this trend is the reduction in operating profits and earnings before tax. Interest expense is a non-operating expense while tax expense is directly dependent on earnings before tax (“Boundless Accounting,” n.d.).
What are the causes and effects of Elf’s performance for those three years?
The causes of Elf’s performance for the three years are the high cost of goods sold and operating expenses. The firm should devise a way of reducing these two items. The effects of these two runaway items are low and reducing operating profits leading to very low and reducing net incomes. If the company maintains its current trend, it could start making loses as early as in the next three years.
References
Boundless Accounting. (n.d.). Retrieved from https://courses.lumenlearning.com/boundless-accounting/chapter/the-income-statement/
Kenton, W. (2019, March 29). Common Size Income Statement. Retrieved from https://www.investopedia.com/terms/c/commonsizeincomestatement.asp