Question

Corporation Income Statements (excerpt)

(dollars in millions) 2019 2018 Sales to customers $71,890 $70,074 Cost of products sold 21,685 21,536 Gross profit 50,205 48,538 Selling, marketing and administrative expenses 19,945 21,203 Research and development expense 9,095 9,046 In-process research and development 29 224 Interest income -368 -128 Interest expense, net of portion capitalized 726 552 Other (income)expense, net 484 -2,064 Restructuring 491 509 Earnings before provision for taxes on income 19,803 19,196 Provision for taxes on income 3,263 3,787 Net earnings $16,540 $15,409 Horizontal Analysis Compute the difference in each line item from 2018 to 2019. Using 2018 as a base year, determine the change and percentage change in each line item from 2018 to 2019. Did sales to customers increase or decrease from 2018 to 2019? Did net income increase for decrease from 2018 to 2019? What line item(s) is (are) driving the differences between sales to customers and net income from 2018 to 2019? Vertical Analysis Compute each line item as a percentage of sales for 2018 and 2019. Which line items makes up the largest proportion of sales in 2018 and 2019? (Keep in mind that some of the items like gross profit and earnings before provision for taxes on income are subtotals.) Comment of any changes in the income and expenses as a percent of sales from 2018 and 2019.

Answer 1

Horizontal analysis:

				Increase/(decrease)
	2019	2018		Amount	Percent
Sales to customers	71,890	70,074		1,816	2.59%
Cost of products sold	21,685	21,536		149	0.69%
Gross profit	50,205	48,538		1,667	3.43%
Selling, marketing & administrative expenses	19,945	21,203		-       1,258	-5.93%
R&D expenses	9,095	9,046		49	0.54%
In process R&D	29	224		-           195	-87.05%
Interest income	-             368	-             128		-           240	187.50%
Interest expense, net of portion capitalized	726	552		174	31.52%
Other (income)/expense	484	-         2,064		2,548	-123.45%
Restructuring	491	509		-             18	-3.54%
Earnings before provisions for tax	19,803	19,196		607	3.16%
Provision for tax	3,263	3,787		-           524	-13.84%
Net earnings	16,540	15,409		1,131	7.34%

Sales to customers increased in 2019 by $1,816 or 2.59%. Net income increased in 2019 by $1,131 or 7.34%. The line items that are driving the differences from 2018 to 2019 are mainly the marginal increase of 0.69% of cost of goods sold, 5.93% decline in selling, marketing and administrative expenses, a 87.05% decline in in process R&D, and a significant 187.50% increase in interest income. All these ensured that net earnings grew by a larger proportion than the increase in sales.

Vertical analysis:

	2019	2018
Sales to customers	100.00%	100.00%
Cost of products sold	30.16%	30.73%
Gross profit	69.84%	69.27%
Selling, marketing & administrative expenses	27.74%	30.26%
R&D expenses	12.65%	12.91%
In process R&D	0.04%	0.32%
Interest income	-0.51%	-0.18%
Interest expense, net of portion capitalized	1.01%	0.79%
Other (income)/expense	0.67%	-2.95%
Restructuring	0.68%	0.73%
Earnings before provisions for tax	27.55%	27.39%
Provision for tax	4.54%	5.40%
Net earnings	23.01%	21.99%

The line items (except the sub-totals) that make up the largest proportion of sales in 2018 and 2019 are cost of products sold, selling, marketing and administrative expenses, and research and development expenses. Cost of products declined marginally in 2019 and so did R&D expenses (both in terms of % of sales). Interest income was 0.18% of sales in 2018 and increases to 0.51% of sales in 2019.

When considering the sub totals gross profit makes up for the largest proportion of sales in 2018 and 2019.