4M BG

The income or profit and loss statement provides a summary of the

revenue earned and the costs incurred over a period of time which is

usually a month or a year. The statement starts with the trading activities,

covering the revenue and direct costs incurred in earning that revenue.

These are followed by the indirect or overhead costs to derive the

operating income:

Revenue $100

Direct costs ($60) Costs incurred in providing products or services

such as raw materials and packaging

Gross profit $40 Also known as trading profit

Indirect costs ($25) Costs incurred in running the business such as

rent, IT and payroll

Operating income $15

Also known as ebit (earnings before interest and tax)

For example, most retailers earn revenue from selling bought-in

products. The direct costs are easily identified as the costs charged by

the manufacturer of those products. Subtracting the direct costs from the

revenue gives the gross profit or trading profit. Deducting the indirect

or non-trading costs such as rent and payroll costs gives the operating

income.

The split between what is classified as direct and indirect is up to

the business to decide and is not always obvious. For a retailer, are the

delivery costs direct (as they relate to moving the products) or indirect (as

they are a consequence of the main activity)? The answer is a commercial

judgment and there is inconsistent treatment in the retail sector. Therefore

comparison of gross profit levels between businesses is not as easy as you

might expect it to be because of the ways different businesses categories

their costs. Hence most comparisons are done at the operating income

level when all costs have been accounted for and the judgment element

removed.

The structure of an income statement is shown in Table 4.3. In the

past dividends used to be shown at the foot of an income statement as a

distribution of profit. These are now shown separately in financial statements

as a movement in shareholders’ equity. Furthermore, in published

accounts the income statement is extended to include a statement of recognized

income and costs. The purpose of this is to show the non-operating

items such as gains in property values or foreign-exchange movements.