BUSI 3016 Week 2 Income Statement Line Read Example

Reading Every Line of One Income Statement in Order: What Each Line Records for a Family Heating and Air Business in 2027, and Five Things the Statement Cannot Tell Its Owner

Student Name

Walden University

BUSI 3016: Finance Essentials Workplace Certificate

Instructor Name

Month Day, Year

Reading Every Line of One Income Statement in Order: What Each Line Records for a Family Heating and Air Business in 2027, and Five Things the Statement Cannot Tell Its Owner

The Statement Being Read

Below is the 2027 income statement for Ozark Comfort Heating & Air, a sixteen-person furnace and air conditioning outfit in southwest Missouri, invented for this course. It covers the calendar year and is prepared by the company's outside bookkeeper. The owner, like many owners of small firms, usually looks at the last line and little else. This read goes through every line in order and says in ordinary words what each one records.

Table 1

Income Statement, Year Ended December 31, 2027

Ozark Comfort Heating & Air and its figures are composite. The company is taxed as an S corporation, so income taxes are paid by the owners personally and do not appear on this statement.

Revenue

The three revenue lines record what customers were billed for work completed during the year, not cash received. Repair service is diagnostic and repair work. Equipment replacement is new furnaces, air conditioners and heat pumps installed. Maintenance agreements are prepaid plans for two tune-ups a year; the line records only the share of those plans for which the visits were actually performed in 2027. Total revenue rose 7.6 percent.

Cost of Goods Sold and Gross Profit

Cost of goods sold records the direct cost of the work: equipment, parts, refrigerant and the wages of the technicians and installers who did the jobs. Gross profit, revenue minus those costs, is what is left to pay for running the company. Gross profit grew in dollars, but as a share of revenue it slipped from 36.0 to 35.0 percent. That share, the gross margin, is the first number to watch, because it shows whether prices are keeping up with costs.

Operating Expenses

The seven expense lines below gross profit record the costs of running the business that do not belong to any one job. Garrison et al. (2021) draw the same line between costs attached to the work itself and period costs of keeping the business open. Office and management salaries cover the dispatcher, the bookkeeper, the service manager and the owner's salary. Vehicle costs cover fuel, insurance on the vans, repairs and leases. Rent is the shop and office. Marketing covers advertising and the company's website. Insurance covers general liability and workers' compensation. Depreciation spreads the cost of owned vans and equipment over the years they are used; it is a real cost, but no check is written for it this year. Other operating expenses gather smaller items such as software, phones and training.

Marketing rose most, by 15.7 percent, after the company added online advertising in the spring.

Operating Income, Interest and Net Income

Operating income, $200,000, is what the business earned from its work after all the costs of running it. It fell 6.5 percent even though revenue rose, because gross margin slipped and expenses grew faster than sales. Interest expense records the cost of borrowing, mainly the line of credit the company drew on in the summer. Net income, $182,000, is the bottom line the owner reads. It fell by $20,000.

Reading the Two Years Side by Side

Comparing the two columns is where the statement starts to answer questions. Revenue grew by $230,000, but gross profit grew by only $51,000, because cost of goods sold grew faster than sales. Operating expenses grew by $65,000, more than the gain in gross profit, which is why operating income fell. In other words, the company did more work in 2027, kept a little less of each sale and spent more to run itself. Interest expense rose by half, a small amount in dollars but a sign that the company borrowed more during the year. None of these changes is large on its own, and together they explain a $20,000 drop in net income in a year when sales rose by more than $200,000. An owner who reads only the bottom line sees a disappointing year; one who reads every line sees exactly where to look.

Where the Statement Goes Silent

Higgins et al. (2023) caution that accounting income is not cash, and this statement leaves at least five things unsaid.

It does not show cash. Revenue is recorded when work is billed, so a large bill unpaid at year end counts as revenue without any money arriving. Answering that takes the other two statements.

It does not separate the owner's pay from the owner's profit clearly. The owner's salary sits in office salaries, while distributions of profit to the owners appear nowhere on this statement.

It does not show work promised but not yet done. Customers who prepaid for maintenance plans in 2027 but have not yet had their visits are a liability on the balance sheet, not revenue here.

It does not show the season. A full year hides the fact that summer and winter carry the business while spring and fall barely cover costs.

It does not show taxes. Because the company is an S corporation, the owners will pay tax on the $182,000 personally, and the business will likely distribute cash to cover it. Beaver (1966) showed that ratios built from financial statements can signal trouble years ahead, but only if the reader understands what each figure does and does not capture.

References

Beaver, W. H. (1966). Financial ratios as predictors of failure. Journal of Accounting Research, 4, 71-111. https://doi.org/10.2307/2490171

Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2021). Managerial accounting (17th ed.). McGraw Hill.

Higgins, R. C., Koski, J. L., & Mitton, T. (2023). Analysis for financial management (13th ed.). McGraw Hill.