Income Statement 

This shows a company income statement and a statement of changes to retained earnings. First, let's start with the income statement, which details the company's revenue and expenses for the year. The items included on an income statement are listed below in order. The indented items are the expense deductions. Gross Sales All invoices of merchandise recorded that year. These are billed sales, not collected sales. Returns Merchandise returned for credit. Net Sales Gross Sales minus Returns. Cost of Goods Sold The accounting value of inventory sold. Gross Margin Net Sales minus Cost of Goods Sold. Operating Expenses Items such as administrative salaries, rent, advertising and depreciation (a non-cash expense)

Operating Margin Gross Margin minus Operating Expenses. Non-Operating Income Income that is not derived from the normal business of the company. For example, income from investments is shown in this category. Total Income The total of the two sources of income. Bond Interest Expense Bond interest expense is paid after all operating expenses are covered, so it is listed on the income statement as a "non-operating" expense. Net Income before Tax Total income minus Bond Interest Expense. Taxes Amounts owed to Federal, State, and local governments. Net Income after Tax Net income before Tax less Taxes. From the income statement, we can determine a company's profitability. The ratios used to measure "profitability" are: Operating Margin of Profit; and Net Profit Ratio. Using the preceding exhibit, we can calculate these ratios for ABC Corporation. The first ratio is the "operating margin of profit." This ratio compares operating margin to net sales and is a basic measure of operating profitability. The ratio for ABC Corporation is: 

Operating Margin of Profit Ratio

= $1,000 / 12000 = 8.3 % or 0.083 as a decimal 

ABC Corporation earns a net profit of 8.3% after tax on its sales. The other ratios that must be known for the exam measure earnings per common share and the portion of earnings paid as a dividend to shareholders. Notice that following the income statement in the exhibit is a smaller financial statement that

shows the changes to the company's retained earnings for the year. These are the earnings that the company has not distributed to shareholders as a dividend, and are shown on the company's balance sheet (covered in the next section). From the statements, we see that Net Income After Tax was $1,000,000 for the year. We also see that preferred shareholders were paid a dividend of $100,000. This indicates that the true "Earnings Available for Common Shareholders" were only $900,000. From the balance sheet of ABC, we know that there are 1,000,000 common shares outstanding. Therefore, the earnings per common share of ABC Corp. are: 

Earnings per Common Share

$900,000 / 1,000,000 Shares = $.90 Per Share

The second ratio measures the portion of "earnings for common" that is actually paid out to common shareholders as a dividend. The "Dividend Payout" ratio is: 

Dividend Payout Ratio

$500,000 / 900,000 = 55.5% or 0.55 as a decimal 

Mature Companies Have High Dividend Payout Ratios, Growth Companies Have Low Dividend Payout Ratios Of its earnings available for common, ABC paid out 55.5% as a common dividend, retaining 44.5% for use in the business. The "average" dividend payout ratio for established companies is about 30%. Companies that pay no dividend or a small dividend tend to be either growth companies or companies in financial distress. Mature companies and utilities tend to have high dividend payout ratios.