Income statements

o Main features of an income statement, eg. revenue, costs of sales, gross

profit and retained profit.
o Use simple income statements in decision making based on profit
calculations (constructing income statements will not be assessed)

WHAT IS AN INCOME STATEMENT?

 An income statement records the income and costs of the business
incurred over a period of time (usually one year)
 The statement is also known as a profit and loss account.

THERE ARE FOUR TYPES OF PROFITS THAT ARE CALCULATED IN THE INCOME
STATEMENT
 Gross profit
 Net profit
 Profit after tax
 Retained profit
THE MAIN FEATURES OF AN INCOME STATEMENT
1.Sales Revenue
 Money generated through selling goods and services.
 It is calculated by Price X Quantity (eg, In 2024 Toys & Trikes Ltd Earned
Sales Revenue of $274 000.
2.Costs of Sales

 The costs of producing or buying in the goods actually sold by the

business during a period of time.
 Includes the costs of raw materials and labour used to produce the
goods.
  (In2024, Toys &Trikes Ltd had costs of sales of $16 000 which included
materials and labour.
3. Gross profit
 Gross profit is made when the revenue greater than the costs of sales.
 Calculated by Sales Revenue – Costs of Sales.
 The Gross profit of Toys & Trikes Ltd was therefore $274 000-$169 000
=$105 000.
4.Net profit
 Profit is made by the firm after all the costs have been deducted from the
revenue.
 Calculated by Goss Profit-Expenses
 (In 2024, Toys & Trikes Ltd made a gross profit of $105 000)
 It had expenses of $48000 which included advertising and equipment.
 The Net profit was therefore $105 000-$48 000=$57 000.
5.Profit after tax
 The income statement for limited companies need to account for
corporation tax paid on net profits.
 In 2024 Toys & Trikes Ltd made a Net profit of $57 000.
 The tax payable was 11 000
 The profit after taxes was therefore was $57 000-$11 000 =$46 000
6.Retained Profit
 Profit remaining for investments into the business after any individuals
have been distributed to shareholders.
 In 2024, Toys & Trikes Ltd made a profit after tax of $46 000.
 The individual payables were $22 000
 The returned profit was therefore $46 000 - $22 000 =$24 000

USING THE INCOME STATEMENTS IN DECISION MAKING

  Income statements inform managers whether the business is
making profit or loss.
 They the comparison of performance of previous years, aid with
future forecast and can be used to make comparisons with
competitors.
Finance managers
 They are able to interrogate the data inorder to beneficial
changes or set new strategic objectives.
Example
Chillies Café sells cold drinks during the summer season in central Berlin.
It’s two selling best products are bubble tea &smoothies.

Questions to consider when Analysing the Income statement

Business is making a profit
 Is the profit higher or lower than last year?
 If higher what has the business done that could have led to this. Eg finding
a cheaper supplier of raw materials or increasing sales due to a new
promotional campaign.
 If lower why is profit failing. (have costs increased, such as higher energy
bills for the premises or have sales fallen due to a new competitor entering
the market.
 Is the profit higher or lower than that of competitors? If lower, what can
be done to become as profitable as other businesses. Eg Does the business
need to improve the quality of the products or increase the product
portfolio.
Business is making a loss
 Is the short term or long term problem?
 Lower profits may be a result of an external stock affecting all businesses as
the 2020 Covid pandemic, in which many businesses had to close or reduce
working hours
  Some losses may be more long- term. Eg E-commerce growth has led to
many high street stores closing down as the number of customers has
dwindled.
 Are competitors making losses (If they are, the business needs to consider
whether the industry is changing to the point that it may become extinct.
 Alternatively, it need to ask tough questions about what can done to solve
with changing market conditions.

PROFITABILITY
o The concept and importance of Profitability
THE IMPORTANCE OF PROFITABILITY
Profit is what the firm earns once the costs have been deducted from the sales
revenue
 Profitability is a measure of how successful a business is
 Profitability can be defined in two ways.
 A measure of how effectively a business converts sales revenue into
profit effectively what percentage of sales revenue is profit
 A measure of how well capital resources invested in the business
generates
 Profitability is expressed in point form which allows comparison of
business performance over time and also comparisons with other
businesses.
Several Stakeholders are interested in Profitability
 Investors
Look carefully at profitability when deciding which business to invest. The
higher their rewards are likely to be.
 Directors and Managers
They consider profitability when assessing business success and
determining future objectives and strategy.
 Employees
May consider profitability was justification for requesting higher wages or better
working condition.

LIQUIDITY
Liquidity is defined as the ability of a business to pay back its short term eg its
suppliers.
 A business that cannot pay its pay debt is considered illiquid
 If a business cannot pay its suppliers, raw materials or components may not
be delivered and production will be delayed.
 If it cannot repay an overdraft, banking facilities may be withdrawn and its
credit rating will suffer.
 Creditors may force it to stop trading and sell its assets so that the debts
owed to them are repaid.
STAKEHOLDERS WHICH ARE INTERESTED IN LIQUIDITY INCLUDE;
 Suppliers want to be reassured that the business is likely to be able to pay
for them.
 Financial providers such as banks want evidence to be able to repay loans
or overdrafts.
 Customers want to be sure that a supplier will be able to produce and
deliver good orders.