5.

3 INCOME STATEMENT

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

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 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)1
• 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.

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.

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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.

Only 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.

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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