Accounting and Marketing, Part 5

Question 1: Define gross profit, operating expenses, and income from operations on a standard income statement.

Answer 1: The standard income statement has a number of different categories. Gross profit is calculated as the net sales minus the cost of the goods sold (also called the cost of production). The operating expenses for a business are any expenses that are not directly related to the production of a good or performance of a service. Some examples of operating expenses are rent, utilities, insurance, depreciation on buildings, and managerial salaries. Income from operations is calculated as gross profit minus operating expenses. This is the company’s profit before adjusting for interest payments, income, or expenses that are not directly related to the business (for instance, royalties on patents, income from investments, losses from unpaid sales). It is also the income before income taxes.

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Question 2: Define income before income taxes, income taxes, and net income (profit).

Answer 2: Once sales and expenses have been fully tabulated, the income statement gives a summary of income. Income before income taxes is the profit the company has made, after adjusting for miscellaneous expenses or income. Because interest expenses are deducted from the total at this point, income before income taxes is usually less than income from operations. Income taxes, of course, are the taxes the business owes to various agencies of the government for the income earned during that particular period. Net income, otherwise known as profit, is the final yield of the business after all expenses and taxes have been considered. This is the amount available to pay stockholders in the form of dividends, or to reinvest in the business. A negative amount here represents a loss.

Question 3: Explain the purpose of tracking cash in a business.

Answer 3: For most companies, having available cash is even more important than turning a profit. A company that takes a loss need not suspend operations as long as it has a ready supply of cash. In the opposite way, a business may appear to be quite profitable and yet flounder if it does not have access to cash. For this reason, it is important to get a sense of how much cash a business has available by looking at its balance sheet. If all the assets of the business are represented by machinery and real estate, for instance, the business has a problem. Employees, after all, cannot be paid in machinery! In order to fully assess a business, one must analyze how much cash it has, as well as how much it is likely to be able to borrow if necessary.

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