ANALYSIS AND INTERPRETATION OF INCOME STATEMENTS 1. General divisions of the income statement.—The income or revenue of a business undertaking is de rived from the sales of its product or service, or from property which it owns. The income may be broadly classified as between primary income, sometimes called operating revenue, and secondary income, or non-op erating revenue. The former represents income de rived from the principal business in which the firm is engaged, while the latter consists of the income de rived from the capital or property of the undertaking invested in outside ventures or controlled by others, such as interest on bonds or money loaned; dividends on securities; rents, sales of by-products or sales of scrap material, and so on.
As the reader has already noted, the expense of con ducting the business includes the cost of materials consumed in producing the commodities or service which the undertaking offers for sale, together with the expenses incurred in selling the commodities or service, and the expenses of administration. The cost and expenses are also classified as between operating expenses and non-operating expenses. Operating ex penses comprise the total cost and expense of securing the primary income or the operating revenues. Non operating expenses may be the cost of securing non operating revenue and the cost of collecting it, or they may be expenses purely in connection with capital in vested in other activities than those in which the busi ness is principally engaged. For the purpose of il lustrating the method to be employed in analyzing and interpreting the income account or statement of an undertaking, a typical income account of a manu facturing organization has been selected. The prin ciples applied are equally applicable to a trading con cern, or to any other form of business organization.
2. Gross sales or gross goods sold, whether for cash or credit during the period un der consideration, will be credited to the sales account. This account should be credited with all valid sales which legally transfer to the purchaser the title to the merchandise disposed of. Sales made "on ap proval or return," or consignments shipped, should not be included as regular sales.
The sales record should disclose the amount of cash sales and sales on credit. This information will be valuable when considering the relation between the outstanding accounts and the total charge sales of the period. For example, if the annual sales on credit
amounted to one million dollars, and if the sales for the different months were uniform, one would next consider what terms of credit are usually allowed. Let us assume that the average term of credit allowed is thirty days, and that the balance sheet dis closes $200,000 standing at the debit of trade debtors. The natural inference would be that either lax collec tion methods were being employed, or else that the amount standing at the debit of trade debtors in cluded bad, doubtful and uncollectable accounts. In ordinary times there will always be a fair proportion of customers discounting bills, so that while the goods may be sold on an average term of credit of thirty days, the aggregate of customers' outstanding ac counts should be less than the amount of two months' sales.
3. Goods on sale or goods have been shipped to customers "on sale or return," or "on ap proval," and have been credited to sales account and debited to trade debtors, the amount should be de ducted from the sales as well as from trade debtors. The value of the merchandise in the hands of others should be shown as a part of the inventory. There should also be deducted, if necessary, a sufficient sum to take care of the depreciation of the goods while in the hands of others, waiting to be sold, and whatever sum it may be necessary -to deduct because of shop worn condition of goods, and so on.
4. Trade discount on it is custom ary to allow trade discounts, a _separate account may be kept for them. In this event, the credit to gross sales will be the gross price with an offset appearing in an account under the caption of "trade discount on sales." It is sometimes urged that an account should be kept for the amount of the trade discount allowed on sales on the theory that such an account meas ures, to a certain extent, the efficiency of the sales manager. The sales manager who is able to keep up volume of sales with the smallest amount of trade discounts is naturally the most efficient manager. The author believes that this contention is of very little practical weight, and doubts the advisability of keep ing this information, by reason of the time and labor necessary to do so.