Costs have a major effect on a firm's profit and, thus, need to be controlled and managed. The key to successful cost control is information and the ability to use that information in the management of the firm. Advanced computer technology has expanded the amount of cost data collected and increased the speed and complexity of analysis. Financial statements and performance reports that used to take hours of recording and calculating can now be ready in a matter of a few hours, with some systems instantly. Performance reports provide comparisons of actual costs against budgeted costs. Effective managers are able to utilize this information and translate it into profitable decisions for their firms.
An income statement is a financial statement that relates revenue (sales) to costs to determine profit. An income or 'profit and loss statement," as it is sometimes called, is a summary of revenue and expenses for a specific period of title.
An income statement has three sections: revenue (sales), cost of goods sold, and general operating expenses. Cost of goods sold represents all expenses associated with the manufacture of the product line including material costs, labor costs, and factory expenses.
The different parts of the income statement identify basic areas of profit potential. Careful examination of an income statement can help identify where improvements or changes need to be made in order to improve profits. For example:
- An increase in sales without an increase in cost of goods sold or operating expenses would result in an increase in income and profit. This might be attained by an increase in price.
- A reduction in the cost of goods sold without a change in net sales would mean an increase in profit. Cost of goods sold may be affected by changes in costs of materials, labor, and/or factory overhead.
- A reduction in general operating expenses would result in larger profits if income and cost of goods sold remain constant. This could occur from a reduction in administrative salaries, energy expense, or expenses of clerical and record-keeping services.
While the income statement is useful in identifying the 'overall status of a firm, it does not clarify the sources of profits or costs among the products the firm offers. Each product needs to be evaluated separately on its contribution to profits. Firms use cost accounting and cost estimating systems to collect data for management. Cost accounting is a branch of accounting that deals with the classification, recording, allocation, summarization, and reporting of current and prospective costs. It provides the means by which management can control manufacturing costs .
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