C HAPTER 24
I NCOME STATEMENTS
In this topic you will learn about
¥ How a profit is made
¥ Importance of profit to private sector businesses, e.g. reward for
risk taking/enterprise, source of finance
¥ Difference between profit and cash
P ROFIT
Entrepreneurs take risk. They spot a business idea and then are willing to take
risk to turn the idea into a new business.
Recap
What is ¥ Risk includes:
meant by ¤ Loss of finance
¤ Personal failure
the term ¤ Time commitment
unlimited ¥ The reward for risk is profit
liability?
¥ Profit is given to the business owners
¤ Sole trader can keep all the profit and take it out of the business as
drawings
¤ Partnerships will share the profits between the partners
¤ Limited companies can pay dividends to shareholders
¤ Co-operatives can share the profit between members
I MPORTANCE OF P ROFIT TO
P RIVATE S ECTOR B USINESSES
¥ Business objectives include:
¤ Survival
Profit
Not all ¤
¤ Growth
businesses ¥ In the short term a business can survive if it is not profitable but in the longer
have an term this will lead to business failure
objective of ¥ Only a profitable business will be able to achieve an objective of growth
profit. ¤ Profit can be reinvested in the business to fund growth
¤ External investors may be attracted to a profitable business
Can you ¥ Profit is an indication of success
remember ¤ Compare profit levels year on year
what these ¤ Compare with other firms operating in the same market
are called? ¥ Profit can be used as a source of finance
¤ It is a cheap way to fund a business in comparison to loans
¤ No interest payments have to be paid!
C OSTS AND REVENUES - RECAP
How will a ¥ Costs are just one side of the profit equation - they look at the money
change in going out of the business
price effect
¤ Total costs = fixed costs + variable costs
revenue?
¥ Revenues are the other side - they look at the money coming into the
If price goes business, businesses generate revenue by selling goods and services
down will
¤ Revenue = quantity sold x selling price
revenue
always go
down or
might it go
up?
P ROFIT
¥ Having considered both sides of the equation – costs and revenues we can now consider the
relationship between them
¤ Total Revenue (TR) – money coming in from sale of goods and services
¤ Total Costs (TC) – money going out to provide for and generate those sales
¥ The relationship between costs and revenue will determine if the business makes a profit or a loss
There is a surplus There is a shortage
(a profit) of $200 (a loss) of $100
TC
TR TR
$1 300
$1 000 TC $1 200
Profit Loss
$800
$200 $100
P ROFIT
¥ In the examination you will need to use the formula for profit
Profit = Revenue – Cost of making
products
C ALCULATING P ROFIT
¥ Restaurant example
¤ Fixed Cost $12 000
¤ Variable Cost $5 per customer
¤ Selling price $15 per customer
¥ Can you calculate the profit or loss for each number of customers?
Customers 0 500 1 000 1 500
Fixed costs 12 000 12 000 12 000 12 000
Variable costs 0 2 500 5 000 7 500
Total costs 12 000 14 500 17 000 19 500
Total revenue 0 7 500 15 000 22 500
Profit / Loss
C ALCULATING PROFIT
¥ There are 2 types of profit
¤ Gross profit and profit
¥ Total revenue – cost of sales = gross profit
¤ Cost of sales is the cost of materials directly used in making a good or
service e.g. raw materials
¥ Gross profit – expenses = profit
¤ Business expenses are all of the other costs incurred by the business
e.g. heat and light and marketing
R ESOLVING PROBLEMS
¥ A business will look at its profit margins and trends
over time to see if it is successful or not
¥ If problems are identified e.g. margins are low or
they are making a loss then corrective action can be
taken
¥ Profit is a simple equation
¤ Revenue v costs
¤ So to improve profitability a business must either
increase revenue or reduce costs
T HE D IFFERENCE BETWEEN P ROFIT AND C ASH
¥ Cash is the money that flows through a business. It is like the flow of blood to
the heart. Without cash flow the business will die!
¥ Profit is revenue minus costs. The difference is unlikely to be sitting in a bank
account as cash. It may already have been reinvested e.g. into stock to be sold
in the future
Profit is not cash
¥ A business may be highly profitable on paper but if it has not received
payment for goods and services it could have cash flow problems. Cash is
required to pay for wages and stock. Working capital is required for the day to
day running of the business
¥ A business can be making a loss but continue to operate as it has enough cash
to meet its working capital requirements
¥ In the short term cash is vital if a business is to survive. In the long term a
business is unlikely to survive unless it turns a profit at some point
¥ In pairs identify a local business you are familiar with, maybe a
sandwich shop or newsagents. Try to identify specific ways in
which the business could increase profit by:
• Increasing revenue
• Reducing costs
• Changing strategy
¥ Recommend the best action the business could take.
What is the formula for revenue?
What is the formula for gross profit?
What is the formula for profit?
Is retained profit an internal or external
source of finance?
5.3 I NCOME STATEMENTS
In this topic you will learn about
¥ Main features of an income statement, e.g.
revenue, cost of sales, gross profit, profit and
retained profit
¥ Use simple income statements in decision
making based on profit calculations
(constructing income statements will not be
examined)
Looked at some basic financial terms and calculations –
can you remember these?
¥ Roger sells 2000 pairs of jeans at $35 per pair
¤ What is his sales revenue?
¥ He buys each pair of jeans from a wholesaler for $15
¤ What are his variable costs?
¤ How much profit does he have so far?
¥ In addition he has to pay overheads of $10000
¤ How much profit does he have left now?
In this unit you are going to look at how a business presents this and
other information in its accounts.
W HAT ARE FINANCIAL STATEMENTS ?
¥ A business has to record all transactions of money
going into and out of the business
¥ These transactions form a numerical history of the
business and are summarised in the financial
statements
¥ These statements show whether the business has
made a profit or a loss and how much it is worth
¥ The two financial statements you will look at here are
¤ Income statements
¤ Statement of financial position
P URPOSE OF FINANCIAL STATEMENTS
¥ Keeps the business and other stakeholders informed
about the businesses performance
¤ Identifies whether the business is making a profit or a
loss
¤ Shows how much the business is worth
¥ Tracks the flow of cash into and out of the business
¥ Informs managers on the payment of suppliers and
receipts from customers
¥ Helps inform future decisions
I NCOME STATEMENT
¥ Shows a summary of a business’ trading and expenses in a given time period
(normally a year) in order to identify whether the business has made a profit or a
loss
¥ The components are:
¤ Sales (revenue)
¢ The total amount of money achieved as a result of selling goods or services
¤ Cost of sales
¢ The costs which are directly related to producing the goods or services sold e.g.
raw materials
¤ Gross profit
¢ Sales revenue minus cost of sales
¤ Expenses
¢ All other costs experienced by the business
¤ Profit
¢ Gross profit minus expenses
I NCOME STATEMENT
Income statement for Nuts and Bolts Ltd 1st December
2018
$m
Sales revenue 650
Cost of sales 325
Gross profit 325
Expenses 247
Profit 78
W ORK OUT T HE P ROFIT FOR N UTS AND B OLTS LTD
A sample Income Statement for Nuts and
Bolts Ltd
$m
Revenue 720
Cost of Sales 290
Gross Profit ?
Expenses 150
Profit ?
R ETAINED P ROFIT
¤ After a business has worked out its profit figure it will have to pay taxation
and then dividends
¤ Taxation (tax) is a compulsory payment to the government
¢ Corporation tax is placed on the profits of businesses
¤ After this a business will have to decide whether it is going to pay a
dividend to its owners
¢ Dividends are payments to owners out of the profit after tax
¤ Whatever is left over after paying tax and dividends is called retained
profit
Profit
minus Corporation Tax
= Profit after Tax
minus Dividends
= Retained Profit
I NCOME STATEMENTS
Calculate the ¥ Rearrange the information below to produce a
gross profit margin
and net profit
completed Income Statement for Dilbert Fashion
margin Ltd (neither the numbers or headings are in the
for Dilbert Fashion
Ltd. correct order)
Expenses Sales Gross profit Profit Cost of sales
¥ Gross Profit = £27m and Net Profit = £4.5m
revenue
$27m $63m $4.5m $90m $22.5m
$m
30 S ECOND CHALLENGE – YOU HAVE LEARNT
SO MUCH !
In pairs take it in turns
to talk finance.
Can you talk about
finance for 30 seconds
without hesitating or
repeating any words? End
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