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In: Accounting

What types of business are more likely to have high profit margins? What types of business...

What types of business are more likely to have high profit margins? What types of business are more likely to have lower profit margins?
If you were a potential investor would rather have a single-step or multiple-step income statement. Why?
In trying to predict future earnings, which is the more relevant figure - net income or operating income?

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Expert Solution

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Questions

1

What types of business are more likely to have high profit margins? What types of business are more likely to have lower profit margins?

The margin depends upon nature and type of the business. Several characteristics will decide the margin of profit.

  1. Competition - Competition adversely affect the margin to the business i.e. if product or services are highly competitive the margin would be less because of price sensitivity. Example telecom industry.
  2. Uniqueness – If business is new and has positive response from market despite of initial capital investment the profit margin would be higher side.
  3. Brand Value – Brand Value will play vital role in making healthy margin therefore the branded product business earn relatively higher profit margin as compared to other similar brands. Example Apple Mobile Phone, Royal Enfield, BMW
  4. Status – Business Status in the eye of society also play vital role in the business margin like in India Johnson's Baby Products are highest seller despite of other brands like Himalayas. Because no one want to take chance or risk to take other branded product because they know our parents had used the Johnson's Baby Products so we will also follow same.

Therefore based on above characteristics business can earn higher margin. Also other parameters such as location, management team, technology also play important role to get higher margin in business.

Conventional trade and businesses have very low margins as traders have capitalised their segments, earned tremendous profits in the past and now use that capital to get reasonable returns on their investments.

2

If you were a potential investor would rather have a single-step or multiple-step income statement. Why?

  1. Single-step income statement Single-step income statements offer a very straightforward accounting of a company's business activity.

All revenues and gains are added together at the top of the statement, while all of the losses and expenses are totalled below them. An example of the equation is represented as:

(Revenues + Gains) - (Expenses + Losses) = Net Income

  1. Unlike single-step income statements, a multiple-step income statement offers detailed information about the gross profit and operating profit of a company.

Operating sections of the statement generally involve revenues and expenses, while non-operating sections detail the gains and losses of indirect activity. The company's specific sources of revenue and expense are itemized and presented as different line items, making it easier for investors to digest performance and evaluate financial health. Accountants record every transaction separately and maintain a vigilant segregation of revenue or expense types.

Based on above explanation a potential investor should have multiple-step income statement because it shows detailed information about company operation and its profitability from core business and expenses incurred under different categories.

3

In trying to predict future earnings, which is the more relevant figure - net income or operating income?

  1. Operating income is the income you generate through your operations. This is your revenue from sales of products and services performed in your daily business operations less the expenses it takes to produce and sell them. Operating income does not take into consideration: income from investments, expenses from financing or taxes, or one-time extraordinary expenses or income items, such as the gain on the sale of an asset.

Operating Income = Gross Income – Operating Expenses – Depreciation and Amortization.

  1. Net income is the final bottom-line income for your business. If your operating income is $15,000 and you paid $1,000 interest on your loan, $2,000 in taxes, and you had $1,000 in dividend income, your Net Income would be $13,000 ($15,000 +$1 ,000 – $1,000 – $2,000).

Net Income = Operating Income + Investment Income – Interest Expense +One-time Extraordinary Income – One-time Extraordinary Expenses – Taxes

Operating income represents how the revenue and expenses flow in and out from business operations alone, regardless of whether your business operates on debt or has extra cash reserves. If your operating income is healthy, your business value will likely be healthy regardless of your net income.

Therefore, In trying to predict future earnings, operating income is the more relevant figure.

For any further clarification feel free to ask


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