Express Each Income Statement Component As

Express Each Income Statement Component As

Problem 1 required: Express each income statement component as a percentage of sales, and comment on the trends in each line from 2013 to 2014.

2014 % Sales 2013 % Sales Comments

Sales $ 1,000,000 $ 1,200,000

Cost of goods sold $ 450,000 $ 600,000

Gross margin $ 550,000 $ 600,000

Operating expenses $ 600,000 $ 450,000

Net income $ (50,000) $ 150,000

Paper For Above instruction

Calculating each income statement component as a percentage of sales provides insightful analysis of a company's operational efficiency and profitability over time. It also facilitates comparative analysis across different periods or companies by standardizing the figures relative to sales, which serve as the baseline metric.

For 2014, the percentage of sales attributable to each component can be calculated as follows:

  • Sales: 100% by definition.
  • Cost of Goods Sold (COGS): ($450,000 / $1,000,000) * 100 = 45%.
  • Gross Margin: ($550,000 / $1,000,000) * 100 = 55%.
  • Operating Expenses: ($600,000 / $1,000,000) * 100 = 60%.
  • Net Income: (($50,000) / $1,000,000) * 100 = -5%.

Similarly, for 2013:

  • Sales: 100%.
  • Cost of Goods Sold: ($600,000 / $1,200,000) * 100 = 50%.
  • Gross Margin: ($600,000 / $1,200,000) * 100 = 50%.
  • Operating Expenses: ($450,000 / $1,200,000) * 100 = 37.5%.
  • Net Income: ($150,000 / $1,200,000) * 100 = 12.5%.

Analysis and Trends:

The gross margin increased from 50% in 2013 to 55% in 2014, indicating improved efficiency in production or procurement, possibly through cost control or better supplier negotiations. This upward trend reflects increased profitability at the gross level.

However, operating expenses significantly increased from 37.5% in 2013 to 60% in 2014. This sharp rise suggests higher operational costs, which could be due to increased marketing spend, administrative costs, or other operational factors. The rise in operating expenses relative to sales has negatively impacted profitability, as seen in the net income dropping from a positive 12.5% in 2013 to a negative -5% in 2014.

The net income trend highlights a decline in overall financial performance despite improved gross margin. The negative net income in 2014 underscores potential issues in managing operating expenses or other non-operational costs. Continuous monitoring and cost management are vital for restoring profitability.

In summary, while gross margin improved from 2013 to 2014, rising operating expenses offset these gains, leading to a decline in net income. These percentages help stakeholders identify areas of strength and weakness, guiding strategic decisions to enhance future performance.

Compute Financial Ratios for 2014

The second problem involves calculating key financial ratios for 2014: accounts receivable turnover, inventory turnover, and net margin.

Accounts Receivable Turnover

This ratio measures how efficiently a company collects its accounts receivable. It is calculated as:

Accounts Receivable Turnover = Net Sales / Average Accounts Receivable

Given that net sales for 2014 are $3,400,000 and net accounts receivable remains at $360,000 (since the average is assumed consistent across the year), the calculation is:

Accounts Receivable Turnover = $3,400,000 / $360,000 ≈ 9.44 times

Inventory Turnover

This ratio indicates how many times inventory is sold and replaced within a period:

Inventory Turnover = Cost of Goods Sold / Average Inventory

Using COGS of $1,600,000 for 2014 and average inventory, calculated as (beginning inventory + ending inventory)/2, which is ($440,000 + $480,000)/2 = $460,000:

Inventory Turnover = $1,600,000 / $460,000 ≈ 3.48 times

Net Margin

Net margin expresses the percentage of revenue remaining after all expenses:

Net Margin = Net Income / Sales

Net income for 2014 is not directly provided, but can be calculated as follows based on operating and non-operating expenses: since sales are $3,400,000 and COGS is $1,600,000, gross profit is $1,800,000. Operating expenses are $780,000. Therefore, assuming no other income or expenses, net income is:

Net Income = Gross Profit - Operating Expenses = $1,800,000 - $780,000 = $1,020,000

Thus, net margin:

Net Margin = $1,020,000 / $3,400,000 ≈ 30%

These ratios offer insights into operational efficiency and profitability for 2014. The accounts receivable turnover suggests effective collection processes, while inventory turnover indicates inventory management efficiency. The net margin demonstrates the company's ability to convert sales into profit, which is relatively healthy at 30%, especially considering the context of the company’s expenses and gross profit margins.

Conclusion

Analyzing these financial metrics and ratios reveals underlying strengths and weaknesses within the company’s operational framework. Improvements in gross margin contribute positively; however, rising operating expenses threaten future profitability. The efficient collection and inventory management are positive signs, but ongoing expense management remains critical for sustaining profitability.

References

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  • Weston, J. F., & Brigham, E. F. (2018). Managerial Finance (15th ed.). Cengage Learning.
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