Financial Accounting | Revenue, Expenses, and Profitability

Financial Accounting

Revenue, Expenses, and Profitability

Overview

This topic focuses on how businesses recognize revenue and expenses, calculate cost of goods sold (COGS), and analyze profitability. Understanding these components is essential for preparing accurate income statements and evaluating financial performance.

Key Concepts and Practices

Revenue Recognition: Revenue is recorded when earned, not necessarily when cash is received (accrual basis).
Expense Recognition (Matching Principle): Expenses are recorded in the same period as the related revenue.
Cost of Goods Sold (COGS): The direct cost of producing goods sold during the period.
Gross Profit: Revenue - COGS
Operating Income: Gross Profit - Operating Expenses
Nonoperational Items: Include interest income/expense, gains/losses on asset sales, and other peripheral activities.
Net Income: Final profit after all revenues and expenses: Net Income = Revenue - Expenses
Profitability Ratios:
- Gross Margin = Gross Profit / Revenue
- Net Profit Margin = Net Income / Revenue

Step-by-Step Example

Problem: A business has $100,000 in revenue, $60,000 in COGS, and $25,000 in operating expenses. What is its net income?

Step 1: Calculate gross profit:
Gross Profit = 100,000 - 60,000 = 40,000

Step 2: Calculate net income:
Net Income = 40,000 - 25,000 = 15,000

Answer: Net Income = $15,000

Quick Tip

Always separate operational and nonoperational items on the income statement. This helps users evaluate core business performance versus incidental gains/losses.