5.
3 Income statements
5.3.1 What profit is and why it is 5.3.2 Income statements:
important:
• How a profit is made? • Main features of an income statement,
• Importance of profit to private sector e.g. revenue, cost of sales, gross profit, profit and
businesses, e.g. reward for risk- retained profit
taking/enterprise, source of finance • Use simple income statements in decision
• Difference between profit and cash making based on profit calculations (constructing
income statements will not be assessed)
What is profit? And how it’s made?
• For most business, profit is the main objective
Break-even point: point where costs are equal to revenue= no profit no loss point
1 billion dollar (investment) 5 year to earn 1 bill dollar = break even in 5 years
PLC you are expected to publish your income statement in a newspaper.
• Profit is the money left over after total costs have been subtracted from the sales
revenue. The simple equation for profit: Profit = Sales revenue – total costs
• Profit can be made by:
o Increasing the sales revenue, so that it is higher than the production costs
o Reducing the production costs
o A combination of 1 and 2
Profit = Sales revenue – total costs
Sales revenue= number of units sold x selling price of each unit
SR of Tesla in India= 1000x20,00000= ????
Total costs= cost of sales + Overheads/other expenses
Cost of sales: Variable/direct cost of selling/producing your product: Labour wages,
raw materials, packaging
Overheads: Fixed/indirect cost of selling / producing your product: Rent, marketing
cost, power bill, salaries to staff, interest on loan, transportation cost, admin expenses
Gross profit: Sales revenue – cost of sales costs
Net profit: Gross profit – overheads
PAT, Retained profit (final profit)
• Difference between profit and cash:
• Income statement is different than cash flow forecast.
• A loan seems like cash inflow but it’s a cost in income statement.
• Income statement only takes care of revenue expenditure, so buying a new asset
looks like cash outflow but it is not calculated in income statement.
• Profit isn’t same as cash, it can be in form of cash, but it can also be in form of credit.
If a company makes $40,000 in sales, but only $20,000 is in cash and the other $20k
is in credit. The business only has $20,000 in cash to pay costs. Credit is ‘promised’
cash but not physical, and therefore, can’t pay for costs. So, in this case, if the
business makes $40,000, and the costs are $15,000 it will make $25,000 in gross
profit (theoretical profit), but only $5,000 in real profit
• Income Statement – A business account that records all the incomes of a business
and all the cost paid over a year – to see if it is making profit.
• It will be used by managers, banks and investors to see if a business is making profit:
o to compare with previous years - if it is greater than the year before
o to see if it is higher than competitors
• The main features of an income statement include:
o Revenue
o Costs
o Gross Profit: profit made after costs of goods sold are taken away from revenue
o Net Profit (‘Profit’): profit made after taking away other expenses aka overheads
o Retained Profit – the net profit after taking away taxes and payments to owners –
which is reinvested back into the business
A sample Income statement:
Worked example: Sample exam question on income statements from textbook page 324
Income statement for Taste of Asia plc for the year ending 31/3/2020(£ million)
Sales Revenue 80
Cost of Sales 45
Gross profit 35
Overheads 15
Profit, Net Profit, Operating profit 20
Finance cost 05
Profit before tax 15
Corporation tax 03
Profit after tax (PAT) 12
Dividends 10
Retained profit 02
Use of simple income statement in decision making:
• A business makes decisions and set targets for future
• looking at ways to maintain or improve profit if a drop is seen
• Increasing the amount of revenue
• Order raw materials in bulk
• Use cheaper materials
• Improve production efficiency
• Cut down on overheads/expenses
• Decision to pay more dividends to make shareholders happy and attract investor
• If a business is thinking to relocate a factory, they will make a forecast income
statement in both locations and compare
Type-1: Sample exam question on income statements from Specimen 2020 paper-1
Type-2: Sample old exam question on IS from Nov-2013 paper-1, page no 347
Income statement for ABC Plc. for the year ending 31/03/2013
Sales Revenue 280
Cost of Sales 100
Gross profit 180
Overheads 30
Profit, Net Profit, Operating profit 150
Finance cost 15
Profit before tax 135
Corporation tax 40
Profit after tax (PAT) 95
Dividends 25
Retained profit 70
Answers to Student's Book activities
Knowledge check (page 320)
1 Define the following terms:
a) Revenue: The money a business receives from customers.
Alternatively: selling price x quantity sold
b) Cost of sales: The cost of the raw materials needed to make the product.
c) Overheads: Costs that are not associated with making a product but that are
still essential for a business to operate.
2 Identify four overheads that the business might have to pay.
Any four from: rent; salaries (not wages); electricity; rates; power; marketing;
transport costs; administration costs; interest/finance costs.
3 Calculate the business's revenue.
40 000 x $240 = $9 600 000
Student answers should show working and include the currency
4 If each unit cost Al Hasawi International $200 to make, calculate the business's
gross profit for the year
Sales $9 600 000
x
Costs of sales = 40 000 $200 $8 000 000
Gross profit $1 600 000
5 Student answers should show working and include the currency.
Calculate the business's profit for the year.
$1 600 000 $1 400 000 = $200 000
Student answers should show working and include the currency.
Knowledge check (page 324)
1. Explain the following terms that might appear on an income statement:
a. Revenue: The money received/coming into a business from customers/selling
its product or service.
b. Retained profit
The profit earned over a period of time that is the business's to reinvest.
Alternatively: The bottom figure of an income statement after all the costs have
been taken off.
2. Calculate the year's profit.
$4.0 million — $2.5 million = $1.5 million
Student answers should include workings out.
3. Define the following terms:
a. Gross profit: The profit made once the cost of sales has been
subtracted. Alternatively: sales revenue — cost of sales = gross profit.
b. Overhead: The costs incurred by a business that are not directly linked to
producing the product.