[MUSIC] Remember the question imposed at the end of the last video. I asked you, which are the two accounts from the bond sheet you will like to know more about? Besides the ending balance. Without taking a look to your answers, I've read the the most brought in accounts are the profit and loss accounts and the cash accounts. So let me explain this. The profit and loss account gives information about the profitability of the business. How efficient are my operations? How am I increasing the net worth of the shareholders with the operations? The cash accounts is giving me information about how is the business generating and consuming cash and obviously we can not afford running out of cash. Therefore, we need really to have control of these generation and consumption of cash. In the next week I'm going to explain a financial statement that takes care of the cash account. This week we are going to introduce a new financial statement that explains the profitability of the business. This financial statement is called the profit and loss account or the income statement. To prepare this income statement we take all the revenues and expenses from the PNL account on the balance sheet. And we organize all these revenues and expenses in sort of an analytical way. So now I am going to guide you step by step in order to prepare the income statement for the campus bookstore. The top line in the income statement are the revenue, the sales. So here we recognize the total amount of sales of the campus bookstore. No matter whether they are cash sales or credit sales. So to recognize revenues it really doesn't matter whether you have to like it or not. The sales are recognized because we have delivered the books and we have received the cash or at least we have the promise of receiving this cash in the future. So, the total amount of sales you recognize here in the campus bookstore is 180,000 euros. On the one hand we have the 120,000 euros that we sold in cash. And then we have the 60,000 euros that we sold on credit, and the addition of both is 180,000 euros. Next we write the cost of the books sold. So we write the purchase costs of the books that we sold. And the total amount here is 125,000 euros. In the case of the campus book store, we are talking about the commercial company. So, the only cost we include here is the purchase cost of the books. In the case of a manufacturing firm, the cost of goods sold would include all the production costs. So not just the cost of raw materials, but also the cost of labor, that participate in production. The depreciation of the machinery in production, utilities and so on and so forth. At the end of the day we would include any cost that has to do with the production process of the product that we are selling. So we have the sales, we have the cost of goods sold, and here we calculate the first profit. We call it the gross profit or gross margin. As you see, the campus bookstore has a gross margin of around 30% of sales. So this would be like a measure that you could compare to other competitors. Next, we include the rest of the operating expenses. So here I'm going to take into consideration the salary of Christina, the utilities, the rent expense. So I put all these under SG&A, selling and general and administrative expenses. And write below I am writing here also, depreciation and amortization for $6,000 in euros. After that, we can calculate the new bottom line. And here we're going to have the Operating Profit. So we have the revenues minus all the operating expenses. The cost of goods sold, SG&A, depreciation. And we have the operating profit. The operating profit doesn't take into account any financial income or expense. So, it doesn't really matter how the business was financed. At this level, the only thing that shows here is revenues minus operating expenses. The operating profit is often called earnings before interest and taxes, EBIT. And actually sometimes companies also provide another intermediate profit measure which is EBITDA, earnings before interest, taxes, depreciation and amortization. So that would be the gross margin minus the SG&A. Or in other words it would be the operating profit plus depreciation on amortization. Okay, after operating profit what we do is to recognize all of the financial income and expense. In this case we only have financial expenses, the interest from the bank loan. And so after subtracting here the interest expense from the operating profit, we get the earnings before taxes, the profit before taxes. So finally the last thing we have to do is add the tax expense. And after the tax expense were going to get the net income or the net profit for the year. As you see here the operations for the first year of the campus bookstore have been profitable. The total profits have been 8,400 euros. Now my questions is how do you know whether this is a high profit or a low profit? In our case the return on sales is the net income, which is 8,400 euros, divided by the total amount of cells, 180,000 euros, and that's 4.7%. Now, this number by itself probably doesn't tell anything. So, the next thing we should do is to compare it to other companies. So, then compare this number with the numbers of other companies, or to compare it to previous years. In our case we don't have any other companies and we don't have previous years so let's keep it here for the future and we will see. The second thing we could do is to estimate return on equity. In other words how much have investors invested in this company. Well in the beginning of the year the only thing they had invested is the 50,000 of the share capital that you see on the balance sheet. And so with this 50,000 they have generated a profit of 8,400 euros and this is the profit, the net profit is increasing the net worth of the shareholders. So if you estimate the ratio here you get a return on equity of 16.8%. Now it's up to you to decide whether this is enough for you or not. You should convert this with your expected rate of return. So it depends on your cost of opportunity, of the more you have invested in this company. And alternative to calculate these ratio would be to use as a denominator the average owner's equity year into year. Because it's true that you only invested 50,000 in the beginning. But during the year you have been reinvesting the profits you have generated. So, many times people uses a denominator the average amount of owners equity. In any case the percentage is up there, 16%. And so this is the amount that you need to have into consideration. In the operational finance course, you're going to go much deeper into all these ratios. So this is just a flavor of what you can analyze when you see the income statement and the balance. [MUSIC]
