CHAPTER 8: INCOME STATEMENT – MEASUREMENT OF PROFITABILITY

CHAPTER 8: INCOME STATEMENT – MEASUREMENT OF PROFITABILITY

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Revenue
Gross Profit
Profit from Operations
Profit Before Tax
Income Tax Expense
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Under the new terminology, the income statement is now termed as “Statement of Comprehensive Income”. In this book, we will stick to the traditional term for ease of reference. 

In the following chapters, we will use the financial statements, i.e., income statement, balance sheet, and cash flow statement, extracted from Tex Cycle Technology (M) Bhd’s (TexCycle) 2016 annual report.

Note:

We will also refer to the disclosure notes in the same annual report, and readers are encouraged to refer to the annual report when going through these chapters. 

A point to highlight is that the standard financial statement presentation shows the current financial year under review in the left column and the preceding financial year on the right column. This is due to relevance, as the current financial year is the highlight of the annual report.

However, for analysis, I personally find that the reverse is easier to read. Thus, I will be presenting the financial statements using the latter approach.  

Table 1: Financials Extracted from TexCycle’s 2016 Statements of Profit or Loss and Other Comprehensive Income for the Year Ended 31 December 2016 (in RM)

	Notes	2015	2016
Revenue	5 & 6	25,944,697	31,684,570
Cost of Sales		(9,967,778)	(11,593,808)
Gross Profit		15,976,919	20,090,762
Other operating income		1,088,392	6,752,386
Administrative expenses		(5,375,155)	(5,937,370)
Selling & distribution costs		(618,927)	(863,586)
Other operating expenses		(2,883,478)	(3,539,134)
Profit from operations		8,187,751	16,503,058
Finance costs	7	(101,312)	(35,343)
Interest income		25,181	48,889
Profit before tax	8	8,111,620	16,516,604
Income tax expense	10	(737,988)	(1,339,922)
Profit for the year		7,373,632	15,176,682

Revenue

Note 5 on page 88 of TexCycle’s 2016 annual report gives the breakdown of the group’s revenue, as shown in Table 2.

Table 2: Revenue Breakdown (in RM)
	2015	2016
Provision of waste recovery and recycling services	23,319,381	28,948,753
Rental income from investment property	974,592	1,012,194
Rental of recycled products	903,497	816,618
Trading of chemicals and other products	381,634	562,226
Sales of goods	365,593	344,779
	25,944,697	31,684,570

Such disclosure allows investors to understand which businesses generate revenue. Additional details on the performance of the company can also be found in “Segment Information” section. In the case of TexCycle, its “Segment Information” is presented under Note 30, from page 111 to page 115. 

Gross Profit

Gross profit is used to see how profitable the company is after taking into consideration the direct costs, which are costs directly related to the manufacturing process of a product or services. Examples of direct costs relating to manufacturing processes are raw materials, direct labour, depreciation of machineries and factory, and utility costs. For companies involved in provision of services, direct costs are the costs of sales staff.

Profit from Operations

Profit from operations is the profit after deducting all indirect costs, which are costs not directly related to the manufacturing or sales processes. Examples of indirect costs are administrative salaries, rental of office building, depreciation of photocopier machines, etc. This is the profit that measures the performance of the business’s core operations.

Items such as interest income, interest expense, and share of profits of associates are costs and expenses that are incurred but not related to the operational activities of the company, and as such they are presented after operating profit.

Under Note 6 in page 88, TexCycle further breaks down the operating costs, as extracted in Table 3.

Table 3: Operating Costs Applicable to Revenue (in RM)
		2015	2016
Direct costs on services rendered		5,686,379	6,386,824
Staff costs		4,208,190	4,853,610
Depreciation of property, plant & equipment		2,806,675	3,089,612
Directors’ remuneration		2,133,720	2,291,800
Amortisation of prepaid lease payments		185,376	185,376
Costs of chemicals and other products sold		164,517	81,859
Raw materials and consumables used		65,242	126,030
Changes in inventories of finished goods		(284,951)	25,580
Other operating expenses		3,880,190	4,893,207
		18,845,338	21,933,898

Profit before tax

Profit before tax is the profit from operations after taking into consideration the financing cost and interest income. If the company has profits coming from its associates and joint venture, which we will explain in the next chapter, it will also be reflected in the profit before tax. These items are not factored in when calculating profit from operations as they are not part of the daily operations of a company.

Income Tax Expense

Taxation is one item that often confuses readers of income statement. While the income statement is prepared following accounting rules, tax payable by the company is calculated based on the Inland Revenue Board’s rules and guidelines.

There is a stark difference between both rules. The income statement is prepared using the accrual concept, while tax payable is calculated based on a cash receipt basis. Thus, profit calculated based on accounting standards is known as “accounting profit”, whereas profit calculated based on tax rules is known as “taxable profit”. Income tax is charged based on taxable profit, and not on accounting profit.

The disclosure on income tax expense can be found under Note 10, on page 91 of the annual report. 

Deferred taxation is a major topic in itself and we will not go into it in details (at least for this book). However, we will touch a little on deferred tax in Chapter 9: Balance Sheet – A Measurement of Financial Health.

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