Tag Cost of goods sold

How to calculate EPS (Earnings per Share)?

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Calculating earnings per share (EPS) allows us to understand how much dollars were earned on each outstanding share of common stock.

In summary, in order to find earnings per share (EPS), we need to take earnings available for common stockholders (the bottom line of the income statement ) and divide it by number of shares of common stock outstanding.

Earnings per Share (EPS) = Earnings Available for Common Stockholders/ Number of Shares of Common Stock Outstanding

Therefore, in order to determine EPS (earnings per share), we need to know earnings available for common stockholders. Earnings available for common stockholders are calculated as follows:

Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

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Gross Profit Margin Ratio

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Gross profit margin ratio (GPMR) is one of profitability ratios. It measures how much of each sales dollar remains after costs of goods are deducted. In other words it measures the relative costs of goods sold.

Gross profit margin ratio (GPMR) = Gross Profit/Sales

EXAMPLE:

For example, if ABC has a gross profit of $1,000,000 and sales of $3,000,000, then the Gross profit margin ratio (GPMR) is calculated as follows:

= 1,000,000/3,000,000 = 0.3333 or 33%

Test yourself

Dillon Corporation has a gross profit of $1,200,000 and sales of $3,500,000.

Required: Find the Gross profit margin ratio (GPMR)

Solution:

The calculation of  Gross profit margin ratio (GPMR) of Dillon Corporation will be as follows: = 1,200,000/3,500,000 = 0.34 or 34%

Conclusion:

The higher the Gross profit margin ratio (GPMR) the lower the relative cost of goods sold. Therefore, the higher the  Gross profit margin ratio (GPMR), the better.

Inventory Turnover Analysis

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Inventory turnover analysis measure the liquidity of a firm’s inventory. It measures how many times the company turns over (sells, uses or replaces) its inventory during a period, such as the financial period.

It is calculated by dividing cost of goods sold by inventory. The formula is as follows.

Inventory Turnover = Cost of goods sold/Inventory

The results can be conveniently used to calculate the average age of inventory (also called average number of days sales in inventory or inventory turnover days) with the following formula:

Average age of inventory = 365/Inventory Turnover

Example of inventory turnover analysis

Assume Gold Co. has cost of goods sold of $1,850,000 and inventory of $680,000. Assume there are 365 days in the year. The inventory turnover analysis and average age of inventory analysis for the Gold Company is conducted as follows:

Inventory turnover analysis:

$1,850,000/$680,000=2.7

This indicates the business turns over its inventory 2.7 times per year.

Average age of inventory:

365/2.7=135.2

Things to note about inventory turnover analysis

The results are only meaningful when used in comparison. It can be compared to industry averages, to the firm’s past inventory ratios and to ratios of competitors.

Industry averages differ significantly between industries for this ratio. This ratio is positive (higher than zero) as long as the firm has any inventory. Generally, a high ratio is considered to be a good indicator.

However, the norm would differ significantly between industries. If the ratio is too high when compared to the norm within the industry, it may mean the company keeps too little inventory and, therefore, may lose some sales. On the other hand, a low ratio may indicate excess inventory and inferior sales. Excess inventory is usually considered to be undesirable as inventory is an investment without return, holding inventory implies costs and prices of goods to be sold may start decreasing.

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Earnings Available for Common Stockholders

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In summary, to calculate earnings available for common stockholders, we need to subtract cost of goods sold, operating expenses, and interest, tax and preferred stock dividends from sales revenue.

To calculate these earnings available, we need to understand the format of the income statement.

Income Statement Format

Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, to calculate earnings available for common stockholders, all we need to do is to subtract cost of goods sold, operating expenses, interest, tax and preferred stock dividends from the sale revenue.

Knowing the the earnings available for common stockholders is very important. Among other uses, it allows us to do the following:

1 – It allows you to calculate EPS:

Calculating EPS allows us to understand how much dollars were earned on each outstanding share of common stock.

2 – It also allows you to calculate the net profit margin ratio:

Net Profit Margin ratio = Earnings Available for Common Stockholders / Sales.

Net profit margin ratio measures how much of each sales dollar remains after all costs are deducted. In other words it measures how successful the firm is in terms of its earnings on sales.

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Calculating net profit after tax

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In summary, to calculate net profit after tax, we need to subtract cost of goods sold, operating expenses, interest and tax from the sales revenue.

To make this calculation, we need to understand the format of the income statement.

Income Statement Format

Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, to calculate net profit after tax, all we need to do is to subtract cost of goods sold, operating expenses, taxes and interest from sales revenue.

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Calculating net profit before tax

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In summary, to calculate net profit before tax, we need to subtract cost of goods sold, operating expenses and interest from sales revenue. We need to understand the format of the income statement.

Income Statement Format

Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, to calculate net profit before tax, all we need to do is to subtract cost of goods sold, operating expenses and interest from sales revenue.

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How to calculate EBIT (Operating Profit)?

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In summary, to calculate EBIT, we need to subtract the costs of goods sold and operating expenses from sales revenue.

To determine EBIT (operating profit), we firstly need to understand the format of the income statement.

Income Statement Format

Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, to determine EBIT, all we need to do is to subtract the cost of goods sold and operating expenses from sales revenue.

Other uses for EBIT

1 – Calculate the Operating Profit Margin Ratio = Operating profit (EBIT) / Sales The operating profit margin measures how much of each sales dollar remains after all costs except for interest, tax and preferred dividends are deducted. In other words it measures how efficient the business manages its operations or how efficiently the firm manages its income statement (keeping a healthy balance between sales and costs).

2 – Calculate the Times Interest Earned Ratio = EBIT/Interest

The times interest earned ratio (Interest Coverage Ratio) measures the ability of the enterprise to meet its financial obligations (interest payments on debt that come due).

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Calculating gross profit

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Calculating gross profit is simple and straightforward. In summary, we need to subtract cost of goods sold from the sales revenue.

Whilst making this calculation, we need to have a good understanding of the format of the Income Statement, as shown below. More details can be found in the format of the income statement section.

Income Statement Format

Sales revenue

 

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, all we need to do is to subtract cost of goods sold from the sale revenue. But how do we find the cost of goods sold? To calculate the cost of goods sold, we need to take the following steps:

Cost of goods sold =

Opening inventory

ADD: Purchases

LESS: Closing inventory

Gross profit allows us, among other things, to calculate the Gross Profit Margin Ratio , which is:

Gross Profit Margin = Gross Profit / Sales GPMR measures how much of each sales dollar is remaining after costs of goods are deducted. In other words it measures the relative cost of goods sold.

Income Statement Format

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Familiarity with the income statement format is important for anyone who wants to succeed in business studies and a business career. You need to be familiar with the format to the point of being able to write down the format from memory.

The income statement, which is also referred to as profit and loss statement (P&L), is one of the most important financial statements. Other important financial statements include the balance sheet, cash flow statement and statement of changes in equity.

A good way to compare the income statement, balance sheet (financial position statement) and cash-flow statement is to think of a river leading to a dam. The income statement and a cash-flow statement record the movement of money over a specific period of time. It is similar to recording the volume flowing down a river over specific period. The balance sheet (financial position statement) is the dam. Everything collects there.

The income statement calculates if the business generated a profit or incurred loss during a specified financial period. In other words, it shows profitability of the organization over a certain period.

If profit was generated during then the bottom line of the statement will be a net profit after taxes, which is also called the net income. The general format is presented below.

General income statement format

Sales revenue

LESS: Cost of goods sold*

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

To calculate Cost of goods sold, one needs to follow the steps:

Opening inventory

Add: Purchases

Less: Closing inventory

= Cost of goods sold