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Imagine that a company is forecasting the following income statement for the upcoming year: ...

Question:

Imagine that a company is forecasting the following income statement for the upcoming year:

Sales 5,000,000
operating costs (excluding depreciation) 3,000,000
Gross Margin 2,000,000
Depreciation 500,000
EBIT 1,500,000
Interest 500,000
EBT 1,000,000
Taxes (40%) 400,000
Net Income 600,000

The company's president is disappointed with the forecast and would like to see the company generate higher sales and a forecasted net income of $2,000,000.

Assume that operating costs (excluding depreciation) are always 60 percent of sales. Also, assume that depreciation, interest expense, and the company's tax rate, which is 40 percent, will remain the same even if sales change. What level of sales would the firm have to obtain to generate $2,000,000 in net income?

Income statement:

The income statement is the statement that is prepared to find out the earnings of the company over an accounting period. It gives us the revenue generated, expenses incurred over the period.

Answer and Explanation:

We will have to follow the bottom-up approach to solve the given question:

Net Income = $2,000,000.00

Add: Taxes = 2,000,000 / 60 x 40 = $1,333,333.33

Earnings before tax = $3,333,333.33

Add: Interest = $500,000.00

EBIT = $3,833,333.33

Add: Depreciation = $500,000.00

Gross Margin = $4,333,333.33

Gross margin = 40% of sales, since operating costs are always 60% of sales.

So,

Sales required
= Gross Margin / Gross margin %
= 4,333,333.33 / 0.40
= $10,833,333.33


Learn more about this topic:

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How to Make an Income Statement: Example & Analysis

from Accounting 201: Intermediate Accounting I

Chapter 5 / Lesson 6
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