Operating IncomeFinancial Statements
Operating expenses are the costs that are created from running the company, but not from creating its goods and services. This includes several expense categories, such as selling, general, administrative, research, development, depreciation, and other expenses. These are all internal business costs, external costs such as interest or taxation are not included. The final result after Operating expenses is Operating Income, which is the total income/loss from manufacturing of goods and all indirect processes of running the business. Strong firms can reduce these charges, function more efficiently than their competition, and maintain higher operating income.
Selling, General, and Administrative
Selling, General, and Administrative expenses capture the costs of selling products, managing the company, as well as indirect expenses that are spread across the company but directly related to selling products. Selling covers the costs directly related to retailing such as advertising, marketing, salaries, commissions, and wages of the sales force. It does not include manufacturing salaries or wages, which are under cost of goods sold. General expenses cover the expected costs of business like utility bills and rent. Administrative fees include the salaries of management personnel and administrative costs of the firm, like traveling expenses. A company with wise management will keep its SGA low. Sales revenue changes year to year, sometimes it decreases and sometimes it expands. It’s very hard to reduce SGA during down times. It generally holds constant. A high SGA should always be avoided, especially if the company has increased SGA when business is doing well. A high SGA will ruin business earnings if the company takes a downswing when this occurs SGA will consume larger amounts of earnings than typical.
Research and Development
Research and development costs summarize the expenses involved in studying and modifying the process of creating products. This includes changing the processes of development. These do not include the cost of developing the product itself, which remain in costs of goods sold. Some industries are driven by research and development, such as computing, mobile device, or automotive industries. These industries’ constant nature of innovate-to-win results in companies whose advantage over each other depends on constant research and development. The endless expenditure on these costs devours large amounts of capital. Companies with technological advantages must also spend vast amounts of earnings keeping those advantages or they will be overtaken by their competitors. It is important to note that companies within these industries can generate great returns and have strong earnings for investors over time. The possibility is not eliminated. However, it is very difficult for companies that have to spend so much to stay competitive.
Physical assets will eventually lose all value and need to be replaced. Depreciation represents the value lost from operating equipment, technology, and buildings over time. Land does not depreciate but does change in value based on its current condition. Any asset other than land has a useful length of time that it can actually be used. After this period of time, it must be replaced with another working asset that serves the same function. Businesses must present an accurate value of assets to shareholders by reducing their value over time. If they did not, they would be misleading shareholders by not displaying the real current value of assets. Depreciation represents this by displaying the loss of value of the asset until the point it is written off. Since the asset was actually used in the production process for the product, it is slowly expensed off over the time it is used. There are many methods for representing depreciation. These depend on how the company chooses to manage devaluation. Four methods of determining depreciation are primarily used by companies: Straight Line, Declining Balance, Sum of Digits, and Activity Method.
Other Expenses summarizes operating expenses that do not fit elsewhere. These are not external expenses such as taxes or interest charges. Other expenses generally consist of one-time expenses that arose during the operating period. These should be one-time events that are do not occur year after year. You should always look to the footnotes for an explanation of these charges. Companies have been known to attempt to hide charges within this section that fit in regular operating expense categories.
Operating Income or Loss and Other Income
Operating Income is the profit after operating expenses have been removed. If this is negative, it is Operating Loss.
Other Income consists of non-recurring earnings. These are one-time events that occur and don’t belong in any other Income category. You should always look at the footnotes to see what is being included as Other Income.
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