Question 3.17: Consider the income statement set out below:

To evaluate financial performance, the following points might be considered:

• The sales figure represents an important measure of production, and can be compared with sales figures of earlier periods and the planned sales figure for the current period to assess the achievement of the business.
• The gross profit figure can be related to the sales figure to find out the profitability of the goods sold. The statement above shows that the gross profit is about 25% of the sales figure or, to put it another way, for every $1 of sales generated, the gross profit is 25¢. This level of profitability may be compared with past periods, with planned levels of profitability or with comparable figures of similar businesses.
• The expenses of the business may be examined and compared with past periods to evaluate operating efficiency. Individual expenses can be related to sales to assess whether the level of expenses is appropriate. Thus, for example, in the above statement, the salaries and wages represent almost 10% of sales, or for every $1 of sales generated, 10¢ is absorbed by employee costs.
• Profit can also be related to sales. In the statement shown above, profit is about 8% of sales. Thus, for every $1 of sales, the owners of the business benefit by 8¢. Whether or not this is acceptable will again depend on making the kind of comparisons referred to earlier. Profit as a percentage of sales can vary substantially between different types of businesses. Usually a tradeoff can be made between profitability and sales volume. Some businesses are prepared to accept a low profit percentage in return for generating a high volume of sales. At the other extreme, some businesses may prefer to have a high profit percentage but accept a relatively low volume of sales. For example, a supermarket may fall into the former category while a trader in luxury cars may fall into the latter category.