Q: Could you explain the legal settlement in 2018 being reflected as a negative number?
A: On the company's income statement, the $43,376 legal settlement is a one-time expense that reduces 2018 accrual net income by that amount. In computing 2018 Business Profit, we begin with accrual net income and then adjust for any one-time events to arrive at an estimate that is not biased by a one-time and non-recurring event. To do so in this instance, we need to remove the $43,376 legal settlement expense from accrual profit – as well as account for distributions and loans to owners – in arriving at Business Profit. Given Business Profit, we can compute the Business Profit Margin.
Q: It seems odd that it is shown as a ($43,378), but the other reductions are not.
A: In preparing the profit and loss statement, the accountant simply listed “Legal Settlement” for the $43,378, which could indicate other income or other expense. To clarify the event, he or she recorded this amount as a negative number to reflect the fact that the $43,378 was, indeed, an expense.
The titles of all the other income and expense items reported on the profit and loss statement for Total Coverage, Inc. clearly state whether the line item is an addition or deduction. However, without expense in the title, a Settlement could go either way, and one could possibly assume the accountant may have made an addition error.
Course overview: Critical Ratios and The First Necessary Condition for Business Success