This lesson adds the shampoo you sell to Five Star's week, then writes the whole week as an income statement.
Twelve sections, about an hour and a quarter all up. One section is one sitting. Do that one and stop.
Three from the lessons so far. Have a go before you open them.
The business makes a loss. The expenses are bigger than the sales revenue, so the income statement ends in a loss.
Five Star spends money on colour, Sanjay's pay and the rent on the salon.
No, Five Star's sales revenue did not change. But the expenses went up, so the profit decreased.
Five Star also sells shampoo off its shelves to its clients. Five Star buys the shampoo in bulk from Bright Street, for $13.00 a bottle, and sells it at $26.00 a bottle. This $13.00 is called cost of goods sold.
| The shampoo shelf, one week | |
|---|---|
| 15 shampoo bottles bought from Bright Street15 bottles × $13.00 | $195.00 of cost |
| 15 shampoo bottles sold15 bottles × $26.00 | $390.00 of sales revenue |
Cost of goods sold is what a business paid for the goods it sold.
Running expenses are the other costs of the business, such as the rent.
Cost of goods sold
15 bottles × $13.00 = $195.00
Running expenses
The colour, Sanjay's pay, the rent, the power, the water and the laundry are all running expenses.
The shampoo is part of the cost of goods sold. Five Star bought the bottle to sell to a client as it is, so the $13.00 is the cost of the thing that was sold.
The colour is a running expense. Five Star does not sell the colour to a client as it is: the colour is used up doing the work.
The rent is a running expense. The rent is the cost of having somewhere to work, and nothing is sold with it.
The conditioner is part of the cost of goods sold, for the same reason as the shampoo: Five Star bought the bottle to sell to a client as it is.
Sanjay's pay is a running expense. Five Star pays Sanjay for his work and sells the hair service to the client, but Sanjay's work is not a thing Five Star buys and sells as it is.
A fixed cost stays the same, regardless of how busy or quiet the salon is. A variable cost goes up and down with the number of jobs the salon does and the products it sells.
Drag the slider to change how many foil jobs Five Star does this week, and watch which costs move.
The rent and Sanjay's pay do not change, so they are fixed. The colour grows by $28.00 with every job, so the colour is variable. The shampoo is variable too: every extra bottle Five Star sells means buying one more bottle, at $13.00.
Ask one question: does this cost go up when Five Star does more foil jobs and sells more shampoo? If the cost goes up, the cost is variable. If the cost stays the same, the cost is fixed.
The shampoo is a variable cost. If Five Star sells twenty bottles instead of fifteen, Five Star buys twenty.
The rent is a fixed cost. The rent is $600.00 a week whether Sierra does two foil jobs or twelve.
The colour is a variable cost. Five Star only pays for the colour when a client is in the chair, so three foil jobs mean paying for it three times.
Sanjay's pay is a fixed cost. Sanjay is paid for every hour the salon is open, so a quiet Wednesday costs the same as a full Saturday.
The foils and developer are a variable cost. They are part of the $28.00 a job, and nothing is used on a day nobody books.
The power bill is a variable cost. Fewer clients mean less time on the dryers, so a quiet week uses less power.
The laundry is a variable cost. Every client uses towels and a gown, so more clients mean a bigger laundry bill.
Every cost Five Star has, sorted both ways: cost of goods sold or running expense, and fixed or variable.
The shampoo is cost of goods sold, because Five Star sells each bottle to a client as it is. The shampoo is variable, because selling more bottles means buying more from Bright Street.
The colour is a running expense, because the colour is used up doing the work. The colour is variable, because more foil jobs need more colour.
Sanjay's pay is a running expense, because Five Star does not sell his work as it is. Sanjay's pay is fixed, because he is paid for every hour the salon is open.
The rent is a running expense, because the rent pays for a place to work. The rent is fixed: $600.00 a week, busy or quiet.
Power, water and laundry are running expenses, because nothing is sold with them. These costs are variable, because more clients use more power, water and laundry.
An income statement shows whether a business made a profit or a loss. It takes every cost away from the sales revenue, including the cost of goods sold and running expenses.
Press a week to see Five Star's income statement for that week.
Now see:
The format is income, less expenses, equals profit or loss.
An income statement takes off both the cost of goods sold and the running expenses, together in one step.
The classified statement shows one more intermediate step: the gross profit.
Both the income statement and the classified income statement take off the same costs, so both end on the same profit or loss.
Press a week to see Five Star's classified income statement for that week.
Now see:
| Income statement | Classified income statement |
|---|---|
| Sales revenue | Sales revenue |
| less Cost of goods sold | less Cost of goods sold |
| ✗ No gross profit line | Gross profit |
| less Running expenses | less Running expenses |
| Profit or loss | Profit or loss |
You may need to draw up your own income statement or, if an income statement is provided to you, take some dollar figures from the statement.
What each grade asks you to do:
Press each grade to see what it adds.
| Five Star's busy week, as a classified income statement | |
|---|---|
| Foil jobs12 foil jobs × $190.00 | $2,280.00 |
| Shampoo15 bottles × $26.00 | $390.00 |
| Sales revenue | $2,670.00 |
| less Shampoo bottles, cost of goods sold15 bottles × $13.00 | $195.00 |
| Gross profit | $2,475.00 |
| less Colour12 foil jobs × $28.00 | $336.00 |
| less Power12 foil jobs × $4.50 | $54.00 |
| less Water12 foil jobs × $1.50 | $18.00 |
| less Laundry12 foil jobs × $6.00 | $72.00 |
| less Sanjay's pay40 hours × $24.00 | $960.00 |
| less Rent | $600.00 |
| Running expenses | $2,040.00 |
| Profit for the week | $435.00 |
Achieved draws up the income statement: every line with its dollar amount.
For Merit, something changes, such as the colour wholesaler putting its price up. Write the statement again with the new figures. A sentence saying the profit changed is not enough.
For Excellence, use those new figures to back up your decision. Saying what you prefer is not enough.
The colour wholesaler puts a job's colour up from $28.00 to $35.00. The reworked income statement shows the new cost of colour and the new profit.
The colour wholesaler puts its price up, so Five Star's profit goes down.
The questions this lesson makes people ask, answered simply.
Yes, cost of goods sold is always a variable cost. But not every variable cost is cost of goods sold. The more shampoo Five Star sells, the more shampoo Five Star buys from Bright Street, so the cost of goods sold goes up.
The colour is a variable cost too, because every foil job uses more colour. But Five Star does not sell the colour to a client as it is, so the colour is a running expense, not cost of goods sold.
No, gross profit is not the money the business keeps. The running expenses still come off the gross profit.
The money the business keeps is the profit, on the last line of the statement.
Because most of what Five Star sells is hairdressing work, not goods. Only the shampoo is bought in and sold on, so only the shampoo goes into cost of goods sold. That is why the cost of goods sold is only $195.00 of $2,670.00 of sales revenue.
Twelve foil jobs are hours of Sierra's and Sanjay's work. Five Star does not buy that work from a supplier, so the work has no cost of goods sold. A business that makes goods to sell, like Bright Street with its shampoo, has a much larger cost of goods sold.
Not always, but use the classified format whenever the organisation buys or makes goods to sell. The classified format shows the gross profit, and an income statement does not. An organisation with no cost of goods sold uses an income statement: income, less expenses, equals profit or loss. In both formats the last line is a profit or a loss, and every line has a dollar figure.
No, an income statement is a list of named lines, each with a dollar amount. A paragraph that describes the statement without the figures is not an income statement, and it cannot support a price or a decision.
An income statement shows dollar amounts, in the usual order: income, less expenses, equals the profit or loss.
Sales revenue $2,670.00, less total costs $2,235.00, equals a profit for the week of $435.00.
Five Star made a good profit this week, because its sales were higher than its costs.
Each of these sentences loses a mark. Work out what is wrong before you open the answer.
The problem. The figures are correct, but the order is wrong. Gross profit is printed before the cost of goods sold that produces it, so the statement is not classified, and nothing on it shows how the $2,475.00 was worked out.
Write the lines in this order: sales revenue, less cost of goods sold, gross profit, less running expenses, profit.
Put each cost before the total it makes.
The problem. That is the profit, not the gross profit. Gross profit is sales less the cost of goods sold only, before the running expenses come off.
Five Star's gross profit for the week is $2,475.00 (sales less cost of goods sold). The profit is $435.00, once the $2,040.00 of running expenses has come off the gross profit too.
Give each line its right name.
The problem. The sentence is true, but it has no figures in it. An income statement is only evidence once the dollar amounts are in it. “Went down” could be a cent or hundreds of dollars, and a marker cannot credit a claim with nothing to check.
After the colour went up, the running expenses rose from $2,040.00 to $2,124.00, the gross profit stayed at $2,475.00, and the profit fell from $435.00 to $351.00, an $84.00 fall.
Rework the statement and put the numbers on it.
The problem. The statement shows the price leaves a profit. The statement does not show how that price was decided, and the description of how a price was set has to come before the statement. A statement with no reasoning before it does not, on its own, support the price.
Five Star sells a bottle of shampoo for $26.00, twice the $13.00 it pays Bright Street for the bottle. In the busy week, the classified income statement shows a profit of $435.00 at that price.
Say how the price was decided first, then show the price in the statement.
The words this lesson introduced, each with an example that is right and one that is not.
Not an income statement (but an opinion)“Five Star did well this week.” That sentence has no income, no expenses, no profit line and no figures.
Not classified (but one expenses line)Five Star's costs are put into a single expenses line of $2,235.00, so the $2,475.00 gross profit never appears.
Cost of goods sold15 bottles × $13.00 = $195.00 of shampoo, bought from Bright Street and sold to clients as it is for $26.00 a bottle.
Not cost of goods sold (but a running expense)The colour on a client's hair. The colour is used up doing the work, so the colour is a running expense.
Running expensesFive Star's colour, power, water, laundry, Sanjay's pay and the rent.
Not a running expense (but cost of goods sold)The shampoo bottles Five Star sells. Five Star sells them to clients as they are.
Gross profitGross profit = Sales revenue − Cost of goods sold
Not gross profit (but the profit)$435.00. That is the profit, after the running expenses have come off the gross profit too.
A fixed costFive Star's rent, $600.00 a week whether Sierra does two foil jobs or twelve.
Not a fixed cost (but a variable cost)The colour. More foil jobs need more colour, so the colour is variable.
A variable costThe colour at $28.00 a job: twelve foil jobs cost more than nine.
Not a variable cost (but a fixed cost)Sanjay's pay. He is paid for every hour the salon is open, full or empty, so his pay is fixed.
These four tasks are about Bright Street, the business that makes the shampoo Five Star sells.
| Bottles sold in the month | 400 |
| Price of one bottle | $13.00 |
| Sales revenue (400 × $13.00) | $5,200.00 |
| Costs, each month | $4,740.00 |
| Cost of empty bottles | $480.00 |
| Cost of ingredients | $1,100.00 |
| Wages | $2,400.00 |
| Rent | $700.00 |
| Interest on the $15,000.00 loan that bought the mixing gear | $60.00 |
a.Sort the five costs into fixed and variable, and give the two totals.
Variable, the empty bottles $480.00 and the ingredients $1,100.00, because both go up when more bottles are made. Total $1,580.00.
Fixed, wages $2,400.00, rent $700.00 and interest $60.00, because none of them move with the number of bottles. Total $3,160.00.
Each group gives its reason: whether the cost changes when more shampoo is made. The bottles and the ingredients rise when more shampoo is made. The wages, rent and interest do not.
b.Write the month as a classified income statement. Then type the gross profit and the profit to check them.
| Bright Street's month, as a classified income statement | |
|---|---|
| Bottles sold400 bottles × $13.00 | $5,200.00 |
| Sales revenue | $5,200.00 |
| less Empty bottles | $480.00 |
| less Ingredients | $1,100.00 |
| Cost of goods sold | $1,580.00 |
| Gross profit | $3,620.00 |
| less Wages | $2,400.00 |
| less Rent | $700.00 |
| less Interest on the loan | $60.00 |
| Running expenses | $3,160.00 |
| Profit for the month | $460.00 |
The statement is in the classified order, every cost has its own line, and every line has a dollar figure. The gross profit comes before the running expenses, and the profit is at the bottom.
Here Bright Street's cost of goods sold and its variable costs are the same $1,580.00. At Five Star they were different: $195.00 of cost of goods sold, and $675.00 of variable costs ($195.00 + $336.00 + $144.00) in the busy week, because the colour is a running expense and variable. Answer the two questions separately every time.
c.The company that makes Bright Street's empty bottles now charges $1.80 for one, up from $1.20. Rework the statement and say what happens to the profit.
| Bright Street's month, reworked for the dearer bottles | |
|---|---|
| Sales revenue | $5,200.00 |
| less Empty bottles400 bottles × $1.80 | $720.00 |
| less Ingredients | $1,100.00 |
| Cost of goods sold | $1,820.00 |
| Gross profit | $3,380.00 |
| less Wages | $2,400.00 |
| less Rent | $700.00 |
| less Interest on the loan | $60.00 |
| Running expenses (unchanged) | $3,160.00 |
| Profit for the month | $220.00 |
“The empty bottles now cost $720.00 instead of $480.00, so the profit falls from $460.00 to $220.00: the whole $240.00 of extra cost comes off the profit.”
The answer reworks the statement instead of describing it. Every line that moved is given its new figure, and the line that did not move is stated as unchanged. The change is traced from the bottles, through gross profit, to the profit at the bottom.
d.At $220.00 profit, is Bright Street's own $13.00 price worth keeping? Weigh it using the numbers, both ways.
“Keeping the $13.00 price leaves Bright Street a $220.00 profit for the month, so the price still covers every cost, including the $60.00 of interest on the loan that bought the mixing gear. But $220.00 is less than half of the $460.00 Bright Street made before the bottles cost more, so there is much less profit to put towards replacing that gear when it wears out. The other choice is to put the price up and pass the extra cost on to the salons, and the risk of that is a salon like Five Star buying the same shampoo cheaper somewhere else. Bright Street should keep the $13.00 price, because losing a salon would take away far more than the $240.00 the costlier bottles do.”
Weighing a choice means naming the other thing the business could do, then giving something good and something bad about each, with a figure on every one, and then choosing.
Go Sierra, go!
You learned the classified income statement on your own salon, with a gross profit in the middle, and then wrote one for Bright Street. You also sorted the same costs into fixed and variable. The next lesson uses that fixed and variable split to work out how many foil jobs Five Star has to do in a week to make neither a profit nor a loss.