About this lesson
The Earnings Statement is a financial report that shows business profitability over some time period. This lesson will focus on the expense portion of the Earnings Statement.
Earnings Statement Part 3
The Earnings Statement is a financial report that shows business profitability over some time period. This module will focus on the expense portion of the Earnings Statement.
When to Use Earnings Statements
The Earnings Statement is prepared for a time period typically a month, quarter, or year. It shows the sales and expenses during that time and ultimately whether or not the company made money (profit) during that time.
- All financial transactions for a time period are accumulated and shown on the Earnings Statement.
- The revenue transactions are placed in one category.
- The expense or cost transactions are normally placed in multiple categories.
- After the expenses have been subtracted from the revenue, the remainder is called Earnings, Net Income or Profit.
- Expense transactions are included if their timing attribute is within the period represented by the Earnings Statement.
- If cash basis, the timing is based upon making a payment for the goods or services.
- If accrual basis, the timing is based upon the receipt of goods or services.
- Special one-time expenses are typically recorded as separate line items so it is easy for analysts to remove them from their ongoing progressions.
- Cost of Goods Sold (COGS) is also referred to as variable cost because these costs vary based upon the amount of sales. The COGS in the Earnings Statement is only the costs of producing the products or services that are sold during the time period associated with the Earnings Statement.
- The COGS, or variable cost, is comprised of three components:
- Direct material – material that is incorporated into a product that is sold.
- Direct labour – labour to manufacture the product sold or labour required to complete a service call with a customer.
- Variable overhead – overhead costs that are directly related to running a manufacturing operation.
- Operational expenses are often referred to as fixed costs, overhead costs, or SG&A – sales, general and administrative.
- Operational expenses can be classified in five categories – these will be discussed in more detail in other modules:
- Fixed costs – typically do not vary from period to period regardless of business activity. These are often based upon a contract.
- Overhead costs – “run the business” costs. These include staffing and operating expenses of business support functions such as HR, Finance, Marketing, and Engineering.
- Program costs – these are the costs of doing projects. Therefore these are the most discretionary of all costs since normally projects can be easily stopped, started, or stretched – which changes the amount of money being spent.
- Interest costs – payment of interest on whatever loan or borrowing instruments used by the company. The payment terms and interest rate are normally determined by the lending the institution.
- Taxes – these expenses are based upon the tax code of the applicable government agencies. Businesses can curtail or expand certain types of business activity in order to minimize taxes.
Hints and Tips
- All transactions are recorded either using the cash basis or the accrual basis – never mix these on a statement.
- Many companies will break the operating expenses into further subcategories within each of the categories mentions, such as R&D, depreciation, sales, IT, or other categories that are of significant importance to their industry.
- Although Interest and Taxes are not normally categorized as operating expenses, their behavior is much closer to operating expenses than to variable costs.
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