[MUSIC] Until the last session, we have learned about balance sheet and now let's look at an income statement. We know that financial statements give perspectives on the health of a business, and income statement is about the profitability of a company. So it answers the questions like these. Are the products or services of the company profitable during a given period of time? The income statement is the best effort to show the revenue and costs associated with it, expenses and the resulting profits for a certain period of time, like a month, a quarter, or a year. So graphically, it looks like this. If this is the revenue, and then you need to pay the cost related to this revenue, and it's called costs of goods sold or COGS. If you subtract COGS from the revenue, you will get gross profit. But you still need to pay the expenses which are not directly related to your product or service. And that's called sales general and administration or SG&A. And the resulting profit is called operating profit. The company still has to pay interest if it has loans and then the company has to pay tax. The resulting profit is called the net profit. Let's look at an example of an income statement. First, there is a currency and the unit and the period for this income statement. In this case, the revenue is $100,000, And the cost for this revenue is $50,000. And if you subtract two from one, then you get gross profit which is $50,000. And there are three lines for the expenses. First sales and marketing, research and development, and general and administrative. The total expenses are $30,000 in line seven. With lines three and seven, you get operating profit which is at $20,000. And after subtracting interest expense and income taxes, you will get a net profit of $15,000. We often call revenue as top line and net profit as bottom line, because of their relative locations in an income statement. Now let's talk about the revenue recognition which is a very important issue. Usually, a company can recognize a sale or revenue when it delivers a product or service to a customer. So revenue doesn't have to be the same as cash. And this revenue recognition is called accrual accounting. Here let's compare cash accounting and accrual accounting. And in cash accounting, revenue is recognized when the cash is received from the customer. And expenses are recognized when the cash is paid to the customer. But for accrual accounting, the revenue is recognized when the product is shipped and the invoice is mailed. And their expenses recognize when the invoice is received from the supplier. Let's look at an example of a cash and accrual accounting. A company sold $1 million worth of products, and the company received payment for $600,000 and the cost and expenses for this company is half a million dollars and the company paid $400,000. And in cash accounting, the revenue is $600,000 with the cost and expenses of $400,000 because these are the cash received and paid. And so profit before tax is $200,000. And if the tax rate is 30% and the company pays $60,000. And so the profit after tax is $140,000. In accrual accounting, the revenue is $1 million. And the cost and expenses are half a million dollars. And so the profit before tax is 500,000. And the profit after tax is $350,000. So usually in accrual accounting, it shows more revenues and profits. Then why do we use accrual accounting? Here's an example. Suppose that a company buys materials for production for six months. And it uses $40,000 of materials each month. And other monthly cost for production is $10,000. And if you assume the monthly revenue is $100,000, in accrual accounting it looks like this. So the revenue is 100,000 and the COGS is the sum of the mature cost and the added monthly cost, so it's $50,000. And if the SG&A, other expenses at $20,000, then the operating profit is $30,000 and it's the same in January and February. On the other hand, if we use the cash accounting and if we assume that the cash for the revenue is collected in each month. And if you pay other cost and the expenses with cash in the same month, then in January the COGS is 240,000 because this is the material the company buys in January. And so in January, in cash accounting, the company records a large loss. But in February, it records a large share profit because it pays only $10,000 as COGS. So we use accrual accounting because it shows more complete picture of the company's financial condition. And another reason could be that public companies want to show increased revenue and profit. So in the United States, accrual method is required for companies with more than $10 million of a annual revenue, and business with heavy industries like auto dealership and grocery wholesalers. In summary, revenue minus cost and expenses is the profit of a company. And we talked about top line and bottom line which are revenue and net profit. And we now know that the revenue is not the same as cash. And in accrual accounting, revenue is recognized when the product or service is delivered.
