now that we have talked about net sales
and other revenues it is time to focus on costs to fuel its sales and produce
the goods it delivers to clients the firm must sustain certain costs the most
common expenses are cost of goods sold selling general and administrative costs
depreciation and amortization interest expenses and taxes cost of goods sold
are expenses necessary to produce the goods the firm sells our dairy company
must buy raw milk from local producers transport process and then package it
before it can sell it to the large supermarket chains it sustains
additional costs to produce cheese from the milk the expenses that are directly
attributable to the production of goods later sold are registered as costs of
goods sold please remember that cogs include the
cost of materials used to create the goods and the amount we’ve paid to
personnel directly involved with the production of the goods the difference
between total revenues and cost of goods sold is called gross profit this is the
profit a company makes after deducting the costs associated with producing its
products gross profit is one of the most important financial indicators for a
business gross profit directly shows us how much our business makes from its
core activity problems at this level are alarming because we have only considered
the cost we sustain to produce the products we are selling a negative gross
profit would mean we are selling our products at a loss if other revenues
represent a substantial part of total revenues you may want to subtract them
when calculating gross profit because we haven’t sustained cogs for these
expenses and this will likely inflate our gross profit margin okay
next we will have the other large category of costs selling general and
administrative expenses also known as operating expenses this is where the
dairy company classifies its expenses for advertising and promotions salaries
of management and personnel not directly involved with production
accounting office and auxiliary personnel office rent and utility bills
such as electricity phone and water bills nearly everything that is not
related to cogs DNA or interest expenses when we subtract cogs and SG&A expenses
from total revenues will obtain EBIT de standing for earnings before interest
tax depreciation and amortization EBIT is one of the most popular measures of
operating income it shows us how much we’ve made once we considered both
direct and indirect expenses depreciation and amortization are two
accounts that reflect the using up of tangible and intangible assets
depreciation refers to assets of a physical nature while amortization is
the term used for intangible assets goodwill licences copyrights etc every
year the plants the dairy company owns become one year older therefore their
value is reduced to account for such reduction the company registers a
depreciation expense in our next lesson we’ll see in more detail how DNA is
calculated in practice once we have considered DNA we arrived at EBIT
earnings before interest in taxes this is another measure of operating
profitability which obviously differs from a beta because it considers DNA the
nature of DNA a non frequently occurring item for most businesses creates a
preference for a beta but there are companies spending a constant amount on
DNA every year therefore they prefer to use EBIT as
their measure for operating profitability interest expenses are a
cost a company bears for receiving financing typically firms receive bank
loans and pay interest expenses for the amounts they owe the dairy company from
our example had to ask for a bank loan when it acquired a new milk processing
system the bank agreed to lend the funds at an interest rate of 6% every year the
firm must pay an interest rate for the amount it still owes such interest
expense is registered in the company’s income statement as a cost
and finally we have taxes there are two things a person can’t avoid and one of
them is paying taxes every firm pays corporate taxes that are proportional to
pre-tax profit it generated the rules according to which pre-tax income
generated by the firm is measured may vary depending on the country where the
company operates once all expenses are considered we arrive at the bottom line
which is called net income this is the excess of
revenues over expenses the profitability of a business after accounting for all
costs these are the typical cost items you will find in an income statement
later in the course we will go through a complete case study and show you how the
items are registered and organized to form a complete income statement this
will do for now thanks for watching