Topic: Income Statements
Accounts are the financial records of a firm’s transactions.
Final Accounts are prepared at the end of the financial year and give
details of the profit or loss made as well as the worth of the business.
Profit
Profit = Sales Revenue – Total cost
When the total costs exceed the sales revenue, then a loss is made.
How to increase profit?
Increase sales revenue
Cut costs
Why is profit important to a business?
It is a reward for enterprise: entrepreneurs start businesses to make a
profit
It is a reward for risk-taking: entrepreneurs has to take considerable
risks when they invest capital in a venture, and profits are a
compensation/reward to them for taking these risks (paid in the form of
profits or dividends)
It is a source of finance: after payments to owners, profits are
reinvested back into the business for further expansion (this is called
retained earnings)
It is an indicator of success: more profits indicate to investors that the
business/industry is worth their time and money, and they will invest more
either int he firm or new firms of their own, in the hopes of gaining good
returns on their investment
For social enterprises, profit is not one of their primary objectives, but
welfare of the society is. However, they will also strive to make some
profit to reinvest it back into the business and help it grow.
Profit is not the same as cash flow! Profit is the surplus amount after
total costs have been deducted from sales. It includes all income and
payments incurred in the year, whether already received or paid or to not
yet received or paid respectfully. In a cash flow, only those elements paid
in cash immediately are considered.
Income Statement
An income statement is a financial document of the business that
records all income generated by the business as well as the costs incurred
by the business and thus the profit or loss made over the financial year.
Also known as profit and loss account.
A simple Income
Statement
Sales Revenue = total sales
Cost of Sales = total variable cost of production + (opening inventory of
finished goods – closing inventory of finished goods)
Gross Profit = Sales Revenue – Cost of Sales
Expenses: all overheads/fixed costs
Net Profit = Gross Profit – Expenses
Profit after Tax = Net Profit – Tax
Dividends: share of profit given to shareholders; return on shares
Retained Profit for the year = Profit after Tax – Dividends. This
retained earnings is then kept aside for use in the business.
Onl
y a very small portion of the sales revenue ends up being the retained
profit. All costs, taxes and dividends have to be deducted from sales.
Uses of Income Statement
Income statements are used by managers to:
know the profit/loss made by the business
compare their performance with that of previous years’ and with that
of competitors’. If profit is lower than that of last year’s why is it falling
and what can they do to correct the issue? If it is lower than that of
competitors’ what can they do to be more profitable and be competitive in
the market?
know the profitability of individual products by preparing separate
income statement for each product. They may decide to stop production
of products that are making losses.
help decide what products to launch by preparing forecast income
statement for the first few years. Whichever product is forecast to have a
higher profit, the business will choose to launch that product
