The income statement of a merchandising company reflects its revenue-generating activities, differing from service organizations by incorporating inventory-related costs. It provides a structured view of profitability, starting with sales and culminating in net income, tailored to the resale of goods.
Page 4 introduces this distinction via Exhibit 6-2, contrasting a service company’s simple revenue-minus-expenses format with a merchandising company’s more complex structure, which includes sales, cost of goods sold, and gross profit before other expenses.
Sales revenue, or net sales, represents the total selling price of merchandise sold to customers during a period. For example, Page 5 cites Computer City’s $900,000 in sales, recognized when earned (typically at the point of sale), highlighting its role as the starting point of the income statement.
This major expense, unique to merchandising firms, is the cost of inventory sold to customers. Page 5 notes Computer City’s $540,000 cost of goods sold, subtracted from sales revenue. It reflects the transfer of inventory costs from the balance sheet to the income statement, emphasizing its significance in profitability analysis.
Gross profit, the difference between sales revenue and cost of goods sold, measures profitability from sales transactions before other expenses. For Computer City, this is $360,000 ($900,000 - $540,000), as detailed on Page 5. Also termed gross margin, it’s a key indicator but not the overall profit.
Additional operating expenses—such as wages, advertising, utilities, and depreciation—are subtracted from gross profit to determine net income. Page 5 lists Computer City’s examples, noting that net income emerges only if gross profit exceeds these costs.
The final component, net income, is the bottom line after all expenses are deducted from revenues. It reflects the overall profitability of the merchandising company for the period, integrating both sales activities and operational costs.
Page 5’s Exhibit 6-3 presents Computer City’s income statement, showcasing the flow: $900,000 sales minus $540,000 cost of goods sold equals $360,000 gross profit, then reduced by other expenses to yield net income. This condensed format highlights cost of goods sold’s prominence, often separated due to its size.
The components tie directly to financial performance metrics. Sales and cost of goods sold drive gross profit, while other expenses determine net income, offering insights into operational efficiency and profitability distinct from service-based firms.