1. 5.3 Income statements. IGCSE Business Studies

2. Lesson Objectives: At the end of the lesson, students should be able to:
5.3.1 Explain what profit is and why it is important:
• 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
5.3.2 Income statements:
• Main features of an income statement, e.g. revenue, cost of sales, gross profit, profit (‘profit’ was known as ‘net profit’ in the 2014 and previous syllabuses) and retained profit and balance sheet.
• Use simple income statements in decision making based on profit calculations (constructing income statements will not be examined)
Class activity included to engage and assess students’ understanding.

3. What is Profits?
Profit (Net Profit): is the difference between revenue and total costs or the difference between the revenue from sales and total costs or the difference between gross profit and expenses.
There are three types of Profits:
- Gross Profit: the difference between the revenue earned from selling products and the cost of making those products
- Profit: as defined above.
- Retained profit: the owners of a profitable business may decide to reinvest some of the profits in the
business.-

4. Accounts: the financial records of one or more
transactions.
Accountants: people responsible for keeping
the accounts as accurate as possible.
Accountants, usually produce the ‘income statements’ or ‘final accounts’ of the business at the end of every financial year. These tell business’ main financial results, and how much the business is worth at that period of the time. Limited companies need to publish their final accounts.

6. How is profit is made?
A business earns a profit by selling its products to customers at a price which is higher than the total costs of making and supplying those products
Profit = Revenue(TR) – Total costs(TC)
Revenue(Sales): is the money earned from the sale of products.
TC = Selling price(sp) x quantity sold(q)
Cost of Sales: the costs of purchasing the goods used to make the products sold.
The total costs to any business of supplying its goods and services can be divide into:
- Cost of sales and
- Expenses: the day to day operating costs of the business.

7. Importance of Profit to Private Sector Businesses Profit is the reward to the business owner for taking risks by investing resources into a business. It is used to: - measure a business success
- measure the performances of managers
- decide whether or not to continue making or selling a product
- finance the purchase of non current assets, expand the business, etc.
- attract investors to help finance business expansion.

8. What is the Difference between Profit and Cash?
Money invested in a business or borrowed by a business will increase cash but nit profit
Capital expenditure e.g. buying a new machine decreases cash but does not decrease profit.
Credit sales increases profit but does not increase cash until the buyer pays.
Businesses often fail because their owners and managers fail to recognize the differences between cash and profit. Cash pays the daily expenses not profit. Cash is important for the business at all times. Profits become more important for the long term success of the business.

9. The income statement is a financial statement which records revenue, costs, and profits of a business for a given time period. It is one of the major financial statements used by accountants and business. The other major financial statements are” the balance sheet, - statement of account, statement of cash flow, and the statement of shareholders equity. The income statement is sometimes referred to as the profit and loss statement (P&L), statement of operations, or statement of income. Our concern here is the first two statements.

10. The trading account:
It shows the difference between the costs of goods sold and the sales revenue, the gross profit.
Note: Cost of goods sold need not be the same as the total value of goods bought by the business. Gross profit does not make any allowance for overhead costs or expenses. In a manufacturing business the direct labor cost and the direct production costs will be deducted from the gross profit before arriving at the Gross Profit Total. The gross profit is not the final profit of the business as all the expenses has to be deducted.

11. The profit and loss account:
Shows how the net profit is calculated
It begins with the gross profit calculated from the trading account
All other expenses and overheads of the business are subtracted
Depreciation: is the fall in the value of a fixed asset over time

12. The profit and loss account for limited companies.
It follows exactly the same principles as the profit
and loss account. The main differences are:
Corporation tax paid on company profits will have
to be shown
Results from the previous year have to be included
The final section of the profit and loss account is
called the appropriation account.

14. Balance sheets. It shows the value or worth of a business at a particular moment in time
Assets: are items of value that are owned by the business Fixed assets – (Land, buildings, equipment and vehicles) they are usually kept by the business for more then a year. Most of the fixed assets depreciate over time Current assets – (cash, stocks and debtors) they are only held for a short period of time
Liabilities: are the items owed by the business Long-term liabilities – they are long term borrowings (they do not have to be repaid within one year) Current liabilities – borrowings which must be repaid within one year

16. Explanation of Balance sheet terms
Working capital (or net current assets): It is used to pay short term debts Working capital = Current assets – Current liabilities
Net assets = Fixed assets + Working capital These assets must be paid for by money put into the business in two ways : shareholders’ fund and long-term liabilities
Shareholders’ founds is everything that is invested into the business by the owners of the company Share capital – is the money put into the business when the shareholders bought ‘newly issued shares’ Profit and loss reserves are retained profits from current and previous years
Capital employed = Shareholders’ founds + long term liabilities
Capital employed = net assets

17. Uses of Income Statement

18. Class Activity with answers: This question can be printed and given to students to engage and assess students understanding at the end of the lesson.
1. Rafiq is the Operations manager at a small factory. The business makes a range of soft drinks using batch production. Last year Rafiq successfully introduced just-in-time inventory control, based on an idea from one of the 40 employees. As the business is planning to expand, Rafiq thinks it would be a good idea to change to flow production

19. (a) i. What is meant by ‘cost of sales’ ii
(a) i. What is meant by ‘cost of sales’ ii. Give two examples of Overhead cost ?

23. LGCSE Paper: 06_0450_11_2016_1.24 Q 3 a – e
Marks Scheme.
3 a ii. Cost of rent / cost of maintenance of machines.