Question

The income statement, also known as a profit and loss (P&L) statement, provides a snapshot of a company's financial performance during a specified period of time. It reports a firm's gross income, expenses, net income, and the income that is available for distribution to its preferred and common shareholders. The income statement is prepared using the generally accepted accounting principles (GAAP) that match the firm's revenues and expenses to the period in which they are incurred, not necessarily when cash is received or paid. Investors and analysts use the information presented in the income statement, and the other financial statements and reports, to evaluate the company's financial performance and condition Consider the following scenario: Green Caterpillar Garden Supplies Inc.'s income statement reports data for its first year of operation. The firm's CEO would like sales to increase by 25% next year. 1. Green Caterpillar is able to achieve this level of increased sales, but its interest costs increase from 10% to 15% of earnings before interest and taxes (EBIT). 2. The company's operating costs (excluding depreciation and amortization) remain at 70.00% of net sales, and its depreciation and amortization expenses remain constant from year to year. 3. The company's tax rate remains constant at 40% of its pre-tax income or earnings before taxes (EBT). 4. In Year 2, Green Caterpillar expects to pay $100,000 and $896,963 of preferred and common stock dividends, respectively.

Answer 1

Completing Year 2 Income Statement for Green Caterpillar:

Particular	Year 1	Year 2 (Forecasted)	Forecasted details relating to Year 2
Net Sales	15,000,000	18,750,000	Increased 25% from year 1
Less: Operating Costs except depreciation and amortization	10,500,000	13,125,000	Operating Costs except depreciation remains 70% of sales
Less: Depreciation	600,000	600,000	Remains constant
Operating Income (or EBIT)	3,900,000	5,025,000	--
Less: Interest Expenses	390,000	753,750	Interest Exp. 15% of EBIT
Pre- Tax Income (or EBT)	3,510,000	4,271,250	--
Less: Tax @ 405	1,404,000	1,708,500
Earnings after Taxes	2,106,000	2,562,750
Less: Preferred stock dividends	100,000	100,000
Earnings available to Common shareholders	2,006,000	2,462,750
Less: Common Stock Dividends	737,100	896,963
Contribution to Retained earnings	1,109,037	1,565,787

Further, completing the following statements:-

- Each Preferrence Share should expect to receive = $ 100,000/10,000 shares

= $ 10 per preferrence share

- Calculating earning per share of Year 1 & Year 2

	Particular	Year 1	Year 2
a	Earnings available to Common shareholders	2,006,000	2,462,750
b	No. of Common stock	500,000	500,000
	Earning Per Share(EPS) [(a)/(b)]	4.012	4.9255

So,EPS is expected to increase from Y-1 of $ 4.012 to Y-2 of $ 4.9255.

-- EBITDA of Year 1 = EBIT + Depreciation

= $ 3,900,000 + $ 600,000

= $ 4,500,000

EBITDA of Year 2 = EBIT + Depreciation

= $ 5,025,000 + $ 600,000

= $ 5,625,000

So,EBITDA value is expected to change from Y-1 of $ 4,500,000 to Y-2 of $ 5,625,000.

-- It is "Wrong" to say that Green Caterpillar's net inflows of cash and outflows of cash at the end of Year 1 and year 2 are equal to the company's contribution to retained earnings, $ 1,109,037 & 1,565,787, respectively. This is because "not all" of the items reported in the income statement involve payments and receipt of cash. Like Depreciation reported in Income statement does not involve receipt or payment of cash.

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