Agribusiness
Library
LESSON L060088: DEVELOPING AN INCOME STATEMENT
Objectives
1. Define revenue, and identify examples of cash
and non-cash revenue.
2. Define expense, and identify examples of cash
expenses and non-cash expenses.
3. Define income statement, and list the
functions of an income statement.
Objectives
4. Compare and contrast cash and accrual
accounting, and demonstrate the ability to
develop an income statement for an agricultural
business using cash or accrual accounting.
5. Calculate business profitability ratios.
Terms
•Accrual accounting
•Asset turnover
•Cash accounting
•Cash expenses
•Cash revenue
•Expense
•Gross margin
•Gross profit margin
•Income statement
•Net margin
Terms
•Non-cash expenses
•Non-cash revenue
•Operating expenses ratio (OER)
•Operating margin
•Operating profit margin
•Profit margin
•Return on assets (ROA)
•Return on equity
•Return on investment (ROI)
•Revenue

Revenue is income or return on an investment.


The two major types of revenue are cash and non-cash
revenue.
A. Cash revenue is income,
in cash form, that is received.

Examples of cash revenue
include wages earned,
cash sales of produced goods,
livestock, crops, bedding plants, or cash received in
exchange for provided services.

B. Non-cash revenue is income for a business in
the form of inventory or investments;
no actual cash is received.

Examples of non-cash revenue
are capital gains on investments,
increases in accounts receivable,
or improvements in inventory that would increase the
change in inventory.

An expense is money paid for products or services
to operate a business.


The two main types of expenses are cash and non-cash
expenses.
A. Cash expenses are money paid in
exchange for products or services
necessary to operate a business.



Operating expenses include input costs to produce a
product or costs associated with a necessary service.
For example, a livestock operation might have cash
expenses (e.g., feed, medical, and veterinary costs).
A vegetable farmer could incur cash expenses (e.g.,
seed, fertilizer, transportation, and advertising costs).

B. Non-cash expenses are monetary value lost
from a business without actually exchanging cash.


One example of a non-cash expense is depreciation (the
decline in value over time) of inventory, such as
equipment or machinery.
Another example of a non-cash
expense is accrued interest
(the cost associated with a loan).

An income statement is a
record of all income and
expenses that determines
the net profit of a business
over a specified period of
time, normally one year.




Income statements have multiple purposes.
A. Income statements help identify possible income
sources.
B. Income statements provide an itemized list of
expenses incurred by the business.
C. Income statements predict future business
performance.


The two major types of accounting are the cash and
accrual methods.
A. Cash accounting is the
simplest form of accounting;
it involves recording income
when cash is received and
records expenses when money is paid out.

This form of accounting is good for small businesses
who do mostly cash transactions.

B. Accrual accounting is the most
common method of accounting; it
involves recording income and
expenses as they are incurred,
regardless of when cash is actually
transacted.


Most large businesses use the accrual
method as their major method of
accounting.
Income statements are composed and
printed periodically (monthly,
quarterly, or annually) to more
accurately assess the financial status
of the business.



Income statements use several
profitability ratios to more
accurately assess the success of the
business.
Some of those ratios are:
A. Gross margin indicates how much money a
business is making after it subtracts production
expenses.


A higher percentage indicates the business has more
money to spend on growth and expansion.
It is calculated by taking gross income divided by net
sales.

B. Profit margin measures the
amount of actual profitability
after tax deductions for a
12-month period.


It is calculated by taking the net
profit after taxes divided by sales.
C. Operating margin is a percentage that more
accurately determines business profitability
because it is does not take into consideration
depreciation and taxes.

It is calculated by taking operating income divided by
revenues and is written as a percentage.

D. Net margin (net profit margin) is a percentage
that indicates the ability of the business to
effectively manage cost control.



This value is often used to compare
businesses that produce similar things.
However, net margin is sometimes used to compare
business that produce different products to evaluate the
percentage of actual profit per dollar of expense.
Net margin is calculated by taking net profit divided by
net revenues.

E. Gross profit margin indicates the amount of
money remaining from sales after accounting for
the production expenses for the product.


It is calculated by taking gross profit divided by
sales, and it is expressed as a percentage.
F. Operating profit margin is a measure of how
effective a business is at controlling its expenses in
a normal business operation.

It is calculated by taking the operating profit for a certain
period of time divided by revenues for that period.

G. Return on equity (ROE) is a calculation that
measures the ability of a business to turn reinvested
earnings into additional profit or earnings.



It is calculated by taking net income
divided by the shareholders’ equity.
It is expressed as a percentage.
H. Return on investment (ROI) is a measure of
profitability that determines how effective a
business is at using its capital investments to
generate profit.

It is calculated by taking the fiscal year’s income divided
by common stock and preferred stock equity, plus longterm debt.

I. Return on assets (ROA) indicates business
profitability.


It is calculated by taking a fiscal year’s earnings divided
by its total assets and is written as a percentage.
J. Asset turnover (total asset turnover) indicates the
ability of the business to utilize its assets to produce
revenue.
In its most general use, asset turnover is calculated by
taking net sales divided by total assets.
 However, it is often calculated for specific assets (e.g.,
cash, fixed assets, and value of inventory).
 In each of these cases, the specific asset is divided by total
assets.


K. Operating expenses ratio (OER) is a calculation
that indicates how efficiently an income producing
property is being managed.


A lower number indicates a
greater profit margin for
investors.
It is calculated by taking
operating expenses divided
by effective gross income.
REVIEW
•What is revenue, and what are some
examples of cash and non-cash revenue?
•What is an expense, and what are some
examples of cash and non-cash expenses?
•What is an income statement, and what is its
function?
REVIEW
•What are the differences between cash and
accrual accounting?
•How do you calculate business profitability
ratios?