The manager of Crown Corporation, and others who review the income statement, can learn a great deal about the business. Specifically, the total deductions from the
$800,000 in revenue are $720,000, which consists of cost of goods sold ($440,000) and operating expenses ($280,000). The manager can also see that the net profit before taxes—$80,000—is a rather small part of the total revenue. Both of these observations might warn of a possible problem with high costs relative to income.
The Crown Corporation can improve its financial controlling and budget plan- ning by doing an item-by-item analysis of the income statement, such as that shown in the first two columns of numbers in Figure 15-8 (see p. 406). Each expenditure
can be calculated as a percentage of total sales. Managers can then compare the percentages with similar figures from prior months and years to reveal trends.
For instance, the first and largest operating expense is $160,000 for salaries and wages. When $160,000 is divided by total sales, $800,000, and the answer is changed to a percentage, the result is 20 percent. If last year the total wages and salaries expense amounted to only 18 percent of sales, the business would know that this expense had increased in relation to total sales. If possible, the company can try to correct this 2 percent increase for the next year by trying to increase sales, raise prices, or get by with fewer employees. The same type of calculation and analysis can be made for each of the remaining expenses on the income state- ment. In addition, managers can determine the percentages of gross profit and net profit in relation to sales. Based on that analysis, budgets can be prepared for the next 12 months, as shown in the last two columns of Figure 15-8.
Unit 5
406
Crown Corporation
Budgeted Income Statement
for 12 Months Ending December 31, 20--
INCOME, EXPENSE, AND PROFIT
AMOUNTS FOR PAST 12 MONTHS
PERCENTAGE OF SALES
AMOUNTS BUDGETED FOR NEXT 12 MONTHS
ESTIMATED PERCENTAGE
OF SALES
Sales
Cost of Goods Sold Gross Profit Operating Expenses Salaries and Wages Advertising/Promotion Depreciation
Utilities Supplies Used Other Expenses Total Operating Expenses Net Profit
100.0%
55.0 45.0
20.0 6.0 4.0 2.5 1.5 1.0 35.0 10.0
100.0%
55.0 45.0
19.0 6.1 3.3 3.0 1.5 1.0 33.9 11.1
$800,000 440,000 360,000
160,000 48,000 32,000 20,000 12,000 8,000 280,000 80,000
$960,000 528,000 432,000
182,400 58,560 32,000 28,800 14,400 9,600 325,760 106,240
FIGURE 15-8 Budgets can be prepared and compared to actual performance from an income statement.
C H E C K P O I N T
How are profit and loss calculated on an income statement?
Chapter 15 • Business Financial Records
U N D E R STA N D M A N AG E M E N T CO N C E P T S
Determine the best answer for each of the following questions.
1. The basic accounting equation is a. income ⫺expenses ⫽profit or loss b. liabilities ⫽assets ⫹capital
c. assets ⫽liabilities ⫹capital
d. income ⫽profit or loss ⫺expenses
2. The information from the income statement needed to calculate gross profit does not include
a. revenue
b. cost of goods sold c. operating expenses
d. All are needed to calculate gross profit.
T H I N K C R I T I C A L LY
Answer the following questions as completely as possible.
3. Why is the balance sheet an important financial statement for potential investors in a company to review?
4. Why is it important to study a company’s financial performance over a period of time and its financial condition
on a specific date?
Assessment 1 5 . 3
thomsonedu.com/school/bpmxtra
PHOTO: ©GETTY IMAGES/PHOTODISC.
Businesses must keep a variety of financial records, budgets, and statements. What kinds of personal financial records do you keep?
Unit 5
408
Fo c u s O n . . .
The Sunbeam Corporation had been experiencing financial difficulties before the board of directors hired CEO Al Dunlap to fix the company.
Sunbeam was a well-known manufacturer of household appliances.
Soon after Mr. Dunlap came on board, Sunbeam’s stock started to climb. Within seven months, he had saved the company $225 million by such actions as firing 12,000 employees, closing 16 of 26 factories, and disposing of unwanted products and facilities.
Employees learned early why others had nicknamed him “Chain- saw Al.” The firm’s culture changed quickly. Before Dunlap’s arrival, the firm was in trouble, with few new products, weakening sales, and declining profits. His arrival seemed to signal a quick turnaround in the company’s financial performance. The stockholders and investors were happy.
But soon after the major cost-reduction steps were completed, sales and profits again began to decline. The new CEO required all product managers to show increased sales. He suggested practices, many uneth- ical, that would make it appear as if sales were rising and expenses were falling. Dunlap eliminated the information technology depart- ment by outsourcing it. As part of that change the computer system was replaced and no backup files were created. Not only did that make it nearly impossible to determine the accuracy of records but it created additional work as all records had to be manually reentered into the new computer system. Chaos prevailed. While the reduced number of employees manually prepared inventory records and invoices, they also had to handle hundreds of calls from upset customers and suppliers.
Dunlap pressured employees relentlessly to produce more. Morale dipped. Budget goals were unrealistic. To make it appear as though goals were being met without creating cash flow problems, some man- agers were forced to postpone paying bills and suppliers were asked to accept only partial payment to keep costs down temporarily. Unrealistic credit terms were extended to large retailers to obtain enough orders to meet sales goals. Large discounts were given to customers to encourage
them to buy well in advance so as to make Sunbeam’s income statement look good. These undesirable business practices led to high inventory levels, while accounts receivable and payable both rose and cash flow weakened. Sales were recorded for the cur- rent year that under accounting rules should have been post- poned to the next year. Profit margins got thinner. The firm was in deep trouble.
The board of directors met and agreed it had made a seri- ous error in hiring Al Dunlap. He was fired. The firm reorga- nized, but it couldn’t recover and fell into bankruptcy. Even though Sunbeam eventually emerged from bankruptcy, its image had dropped among investors, suppliers, and customers.
It has now become a subsidiary of a large international firm, Jarden Corporation.
Ethics–Cost Cutting at any Cost
1. Why do you believe Mr. Dunlap had early success and yet the financial fortunes of the com- pany quickly turned around?
2. Why were Mr. Dunlap and com- pany managers willing to use illegal and unethical practices to try to improve the financial position of Sunbeam?
3. If you were on the board of directors, what questions would you ask Al Dunlap about his beliefs and values before you hired him?
T h i n k C r i t i c a l l y
Chapter 15 • Business Financial Records
1 5 . 4 Analyzing Financial Data
Goals
• Describe several types of financial analysis that help in the under- standing of a business’s financial condition.
• Identify where business owners and managers can turn to get help with understanding and using financial information.
Terms