Chapter 21 - Income Statements
Lesson Objective: To understand the different types of profit
Profit = Revenues - Costs
Not all profits are the same though - we have three different types:
Gross Profit;
Net Profit (or just Profit);
Retained Profit.
Let's start by looking at Gross Profit, which is the simple different between revenue and the costs of making/selling the product:
COGS (Cost of Goods Sold) is also referred as CoS (Cost of Sales) and is calculated by:
COGS includes:
- Direct labor;
- Direct materials or raw materials;
- Overhead costs for the production facility;
COGS excludes:
- Rent;
- Utilities;
- Salaries and wages.
Net Profit is different as it takes into account Total Costs and not only COGS:
Finally, Retained Profit, all the profit the company manages to keep to be reinvested:
Activity 21.1 (p. 269)
Profit is an important number for private sector businesses:
- It's a measure of business success;
- It's a measure of managers' performance;
- Retained Profit is the most important source of internal financing for non-current assets and expansion;
- It's important for attracting investors;
- It shows whether or not to continue making a product.
It's important to remember that Profit # Cash:
- Getting a loan increases cash, not profit;
- Getting investment increases cash, not profit;
- Capital expenditure decreases cash, not profit (likely to increase);
- Selling goods on credit increases profit but does not increase cash immediately.
Test Yourself (p. 272)
To-Do-List:
Case Study - Jimmy Lie (p. 271)
Chapter 21 - Income Statements
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