[MUSIC] The second financial statement we want to prepare here, is income statement, that will tell us about the profitability of the business during the year X2. So, what we're going to do here is take all the information we have in the profit and loss T accounts, and we're going to place in a document, the income statement. So, we're going to analyze in sort of an analytical way, in order to analyze the profitability of the business. How efficient is the company in its operations? Okay, let's start with the sales. So, first of all, we take both credit sales, cash sales, and that's the top line in the income statement. Next, we are going to place there the cost of books sold. So, these are the costs of the books that we have sold, directly related to these sales. And that gives you a very interesting measure, which is the gross margin. And this gross margin, you can estimate it as a percentage of sales if you want, and then compare it to other companies or to previous years. And this is an exercise I'm going to do in session four. Okay great, now, more operating costs below the gross margin. We have the selling, general, and administrative expenses, and we include here two things. First, remember, the salary of Christina, and the utilities, and also the rent expense. So, all of these things are included under selling, general, and administrative expenses. So the way we have here to classify the expenses is a sort of functional weigh, okay? So, cost of goods sold has to do with the cost of the units that you are selling..In a case o f a production company, it would be the production costs of producing those units you are selling. Then you have selling, general, and administrative. And then you could have R & D costs. You could have different kind of costs, according to the function inside the company. An alternative way to classify these costs would be by nature. So, salaries, materials, depreciation and amortization and so on and so forth. In this course we're going to use this format by function of income statement. Okay, next thing, we have the loss on the sale of equipment. That's also an operating expense. It is true though that we're not selling assets every year, so this is not part of our regular operations to sell furniture. However, we need to recognize this and the operating expenses, operating costs. What many people do is, when they take the operating profits, sometimes they adjust it by this kind of nonrecurring expenses. More expenses, operating expenses, depreciation and amortization. And now ,that we have all these operating expenses, we can get the view operating profit. So, remember that operating profit is also called EBIT, earnings before interest and taxes. There is another profit line that some companies use, and it's called EBITDA, earnings before interest, taxes, depreciation and amortization. And so it's an operating profit before the depreciation and amortization. Anyway, let's continue with the rest of expenses. So,the next thing that we have is the interest expense. And so operating profit minus the interest expense. We are going to get the earnings before taxes. And finally, we are going to include here, the tax expense. And once we include the tax expense, we get the bottom line of the income statement, the net profit. And that's actually the increase the net worth of the shareholders, thanks to the operations of the company. Now clearly, this year we were profitable because the final result is positive. However, in order to assess profitability, remember that we should compare this number to other points of references, to other benchmarks. So, one of the things we can do is estimate this number as a percentage of sales. And what you see here, is that return on sales is 3.4%. It's slightly less than previous year. You can also compare this number to the total investment that the shareholders have made in the firm. So, the increase in the net worth of the shareholders has been 7,140 Euros. And now, if you compare these numbers relative to the investment they made in the firm, you get the return on equity. And so what you see here is that the return on equity of investors has been 12.2%, also less that last year. Next week, we're going to do a deeper analysis of the evolution in the performance of the company. And then, we are going to try to understand, the written understand of financial statements, in order to get useful information for decision making. [MUSIC]
