Drill 16 ·
AP Business with Personal Finance: Income Statement (Drill 16) is a practice drill. It contains 5 original questions created by Brian Stewart, a Barron's test prep author with over 20 years of tutoring experience.
Practice reading a single-year income statement: identifying gross profit, calculating margins, tracing a cost-structure change, and selecting the right profitability measure. This drill uses an invented company and original figures.
Cedar & Pine Furniture Co. builds wooden tables and chairs. Its income statement for last year is shown below, in thousands of dollars.
| Item | Amount |
|---|---|
| Revenue | 600 |
| Cost of Goods Sold | (390) |
| Gross Profit | 210 |
| Operating Expenses | (120) |
| Operating Profit | 90 |
| Interest and Taxes | (30) |
| Net Profit | 60 |
Question 1. Which item on the statement represents the money Cedar & Pine has left after paying the direct costs of producing its furniture, but before any other expenses?
Explanation: The answer is gross profit. Gross profit is revenue minus the cost of goods sold, the direct cost of producing the furniture, so it is what remains before operating expenses, interest, and taxes. Net profit is the final figure after all costs. Operating profit comes after operating expenses are also subtracted. Revenue is the starting line, before any costs.
Question 2. What was Cedar & Pine's gross profit margin?
Explanation: The answer is 35%. Gross profit margin is gross profit divided by revenue: 210 / 600 = 0.35. The 10% figure is the net profit margin. The 65% figure is the share of revenue consumed by cost of goods sold. The 15% choice is not supported by the statement.
Question 3. Cedar & Pine's managers expect lumber prices to rise next year. If the company pays more for the wood used to build the furniture it sells, which line on the income statement would increase most directly?
Explanation: The answer is cost of goods sold. The wood used to build the furniture is a direct production input, so a higher price for it raises the cost of goods sold first. Operating expenses cover indirect costs such as rent, administration, and selling, not production materials. Interest and taxes do not record material input costs; any later tax effect would be indirect. Revenue measures sales, not costs, so it would not rise simply because materials cost more.
Question 4. Which of the following best explains why Cedar & Pine's net profit is lower than its operating profit?
Explanation: The answer is that interest and taxes are subtracted after operating profit. Net profit of 60 is operating profit of 90 minus interest and taxes of 30, so net profit is necessarily lower. Unit volume does not appear on the statement. Operating expenses are smaller than cost of goods sold and are subtracted before operating profit, not after. Dividends are not a line on the income statement.
Question 5. A lender reviewing this statement wants a single measure of how much profit the business keeps from each dollar of sales after all costs. Which measure best provides that information?
Explanation: The answer is the net profit margin of 10%. Net profit margin, 60 divided by 600, measures the profit kept from each dollar of sales after every cost. Gross profit margin stops before operating expenses, interest, and taxes. Cost of goods sold is a cost, not a profit measure. Operating profit is a dollar amount measured before interest and taxes, not a per-dollar margin.