Interpreting and understanding accounts
An ACCA case study

Page 3: The Income Statement

Profitable trading is what most business is all about.Acca 18 Diagram 2 So, at regular intervals, a firm needs to know:

This is exactly the information that accountants, and the law, demand. The key document is called the Income Statement. Here is the Income Statement for Halfords plc. After a period as a private company, the business was floated on the stock exchange in 2004. Today it is a leading supplier of bicycles, camping equipment and car accessories as well as running a chain of Autocentres for car repairs.

Acca 18 Diagram 1The Income Statement starts by giving the total value of sales revenue (£863m). From there the statement simply involves a series of subtractions – beginning with the cost of sales. This includes all the direct costs in bringing the product to market, for example, materials, stock and labour. What remains is the gross profit (£473m). This is always the larger of the two profit values because the overhead (or indirect) costs have not yet been subtracted. These are often called operating expenses. They include costs such as marketing, rents and insurance. The resulting total is operating profit (£97m).

From operating profit is subtracted the net cost of finance. This covers the interest paid on long term debt less any interest received from the firm’s investments. The resulting value is profit before tax (£92m). Now corporation tax is subtracted, leaving the profit for the year (£67m). This can then be divided between dividends to the shareholders and retention (retained profits) in the business to fund expansion or other investments.

The Income Statement, often issued at quarterly intervals, is important to managers in revealing trends for sales and costs – both broken down under much more detailed headings. Halfords consolidated Income Statement shows that since 2011:

  • sales have fallen by 0.8%
  • direct costs have risen by 1.3%
  • overheads have risen by 5.3%.

Acca 18 Diagram 11These adverse trends have caused a 24.2% fall in operating profit. The organisation’s shareholders will want to know why profitability had declined. An ACCA qualified accountant would want to investigate all these changes in far more depth to make informed judgments. The Income Statement may also be studied by creditors. Creditors are other firms supplying goods or lending money. They want to see if the business looks creditworthy since limited liability means that they might not be repaid if the company collapsed.

ACCA | Interpreting and understanding accounts

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