Refer to the opening feature about Sseko Designs. Assume that Liz Forkin Bohannon reports current...

Question:

Refer to the opening feature about Sseko Designs. Assume that Liz Forkin Bohannon reports current annual sales at approximately $1 million and prepares the following income statement.

Sseko Designs Income Statement for the year ended January 31, 2014

Net Sales $1,000,000
Cost of sales 610,000
Expenses (other than the cost of sales) 200,000
Net Income $190,000

Liz Forkin Bohannon sells to individuals and retailers, ranging from small shops to large chains. Assume that she currently offers credit terms of 1/15, n/60, and ships FOB destination. To improve her cash flow, she is considering changing credit terms to 3/10, n/30. In addition, she proposes to change shipping terms to FOB shipping point. She expects that the increase in discount rate will increase net sales by 9%, but the gross margin ratio (and the ratio of cost of sales divided by net sales) is expected to remain unchanged. She also expects that delivery expenses will be zero under this proposal; thus, expenses other than the cost of sales are expected to increase only 6%.

Required:

1) Prepare a forecasted income statement for the year ended January 31, 2015, based on the proposal.

2) Based on the forecasted income statement alone, do you recommend that Liz implement the new sales policies? Explain.

3) What else should Liz consider before deciding whether or not to implement the new policies? Explain.

Income Statement:

The statement having amount of the income earned by the entity and corresponding expenses incurred to earn that income is known as income statement. It is prepared to ascertain the profitability of the entity.

Answer and Explanation:

1. Preparation of forecasted income statement:

Particulars Amount ($)
Sales ($1,000,000 X 1.09) 1,090,000
Less: Cost of goods sold ($1,090,000 X 61%) (664,900)
Less: Expenses ($1,090,000 X 1.06) (212,000)
Net income 213,100

Note: The ratio of cost of goods sold is 61% (610,000/1,000,000) and expenses and sales are to be increased by 6% and 9% respectively.

2. Revised net income is $213.100 while old net income is $190,000. It shows increase in net income by 23.100. Based on this result, Liz should implement the new policies.

3. Another points to be considered is as follows:

  • Check the percentage of customers availing discount as more customers are expected to avail higher discount which results in a decrease in net income.
  • Determine the number of customers availing how much credit period. It helps to estimate the cash flow requirement.

Learn more about this topic:

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What Is an Income Statement? - Purpose, Components & Format

from Accounting 101: Financial Accounting

Chapter 2 / Lesson 2
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