Income Statement; Gross Profit Percent; Inventory Turnover – Accounting video

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

5 thoughts on “Income Statement; Gross Profit Percent; Inventory Turnover – Accounting video

  1. Hi Jeetu! I am glad that you found my video on the Income Statement, Gross Profit Percent and Inventory turnover beneficial. Visit my website for additional accounting educational resources (the address is above under the video description "show more"). Also, subscribe to my YouTube channel and join my email list to get notices of newly posted videos and articles. Good luck in accounting!

  2. Virginia, you may visit my website at www . TheAccountingDr . com and you may join my emailing list there. Let me know if you have any further questions (and thank you for watching)!

  3. Your 5 videos on merchandising operations were absolutely perfect.Ā  Thank you!!Ā  This was the perfect supplementĀ to my online accounting class.

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