Income Statement (AQA A Level Business): Revision Note

What is the income statement?

• The income statement records a business's revenue, expenses, profit or loss during a set period, usually a year

  • It records income when it is earned and costs when they are incurred, regardless of when cash actually changes hands

• The income statement has several important purposes

  • It shows whether the business has made a profit or a loss over the period

  • It reveals how efficiently the business is managing its costs at each stage of the profit calculation

  • It provides the basis for calculating profit margins, which allow comparisons to be made over time or with competitors

• Stakeholders use the income statement in a variety of ways

  • Assessing financial performance

    • Managers, shareholders and investors use the income statement to evaluate whether the business is profitable, whether performance is improving and whether it is generating a sufficient return on investment

  • Informing financial decisions

    • Suppliers use profit data to decide how much trade credit to offer

    • Banks and lenders use it to assess the risk of lending

    • Managers use it to identify where costs need to be controlled or where investment is needed

  • Meeting legal and regulatory obligations

    • Government agencies use the income statement to calculate the corporation tax owed

Structure of the income statement

• The income statement is divided into three parts

The trading account

• Records the revenue generated from sales and deducts the cost of sales

  • The result is the gross profit

• The trading account answers the question of how much profit the business made from its core buying and selling activity, before any other costs are considered

The profit and loss account

• Takes the gross profit from the trading account and deducts all remaining costs - operating expenses such as rent, wages and marketing, finance costs such as interest on borrowing, and tax

  • The result is the profit for the year

• This section gives a complete picture of the business's overall profitability after every cost has been accounted for

The appropriation account

• Shows what happens to the profit for the year - how the profit is divided up between different uses

• For a company, this typically means splitting the profit between

  • Dividends

    • The share of profit paid out to shareholders as a return on their investment

  • Retained profit

    • The remainder kept within the business to fund future growth or act as a financial reserve

• The appropriation account does not affect how much profit is made - it simply records the decisions made about what to do with it

An example income statement

Analysis

The trading account

• In 2025 Herringbone Design Ltd's sales revenue was £4.72m and its cost of sales were £1.86m

  • The gross profit for the period was therefore 

$$\begin{gathered} \mathrm{Gross}\mathrm{profit}=\pounds 4.72\mathrm{m}-\pounds 1.86\mathrm{m} \\ =\pounds 2.86\mathrm{m} \end{gathered}$$

The profit and loss account

• In 2025 gross profit was £2.86m and expenses were £1.12m

  • The operating profit was therefore 

$$\begin{gathered} \mathrm{Operating}\mathrm{profit}=\pounds 2.86\mathrm{m}-\pounds 1.12\mathrm{m} \\ =\pounds 1.74\mathrm{m} \end{gathered}$$

• The business also paid £0.02m interest and £0.51m tax

  • The profit for the year was therefore

$$\begin{gathered} \mathrm{Profit}\mathrm{for}\mathrm{the}\mathrm{year}=\pounds 1.74\mathrm{m}-\left(\pounds 0.02\mathrm{m}+\pounds 0.51\mathrm{m}\right) \\ =\pounds 1.21\mathrm{m} \end{gathered}$$

The appropriations account

• In 2025 Herringbone Design Ltd distributed £0.64m to shareholders as dividends

• Retained profit was therefore

$$\begin{gathered} \mathrm{Retained}\mathrm{profit}=\pounds 1.21\mathrm{m}-\pounds 0.64\mathrm{m} \\ =\pounds 0.57\mathrm{m} \end{gathered}$$

Notes to the accounts

• Public limited companies are required by law to include details of

  • Depreciation of non-current assets

  • Directors' earnings

  • Audit details, including the identity and costs of the appointed auditor

  • Employee details, such as the size of the workforce, wage and salary costs, pension liabilities and national insurance contributions

  • Exceptional items, which are significant one-off items of income or expenditure that are unusual but a part of normal trading activities, such as a very large order placed by a customer

Interpreting and amending the income statement

• Reading an income statement means understanding not just the individual figures, but what they reveal about the business's performance

Key questions to ask

• Is the business profitable at each stage, or does it only make a loss once certain costs are added?

  • E.g. A business could show a healthy gross profit but a very low - or even negative - operating profit

    • This would suggest that overheads are too high relative to the gross profit being generated

• Is the gross profit large enough to absorb operating expenses and still leave a meaningful operating profit?

• How significant are finance costs - does the business carry a heavy debt burden?

• How does this year's performance compare with the previous year or with industry benchmarks?

Profit quality

• Profit quality measures how reliable and sustainable a company’s reported profit really is

  • It considers whether profit comes from normal, cash-generating activities or from one-off, non-cash or unreliable sources

Making changes to the income statement

• Amending an income statement means recalculating the figures when one or more inputs change

Profit and profit margins

• A profit margin measures the proportion of revenue that is converted into profit

  • Higher and increasing profit margins are preferable, as they mean more revenue is being converted to profit

Gross profit margin

• The gross profit margin is the proportion of revenue that is converted to gross profit

• It is expressed as a percentage and calculated using the formula

$\mathrm{Gross}\mathrm{profit}\mathrm{margin}=\frac{\mathrm{Gross}\mathrm{profit}}{\mathrm{Sales}\mathrm{revenue}}\times 100$

• Changes in the gross profit margin indicate how well managers are keeping direct costs low or encouraging sales

  • A rising gross profit margin indicates increasing levels of sales revenue and/or falling cost of sales

  • A falling gross profit margin indicates lower sales revenue and/or a rising cost of sales

Operating profit margin 

• The operating profit margin shows the proportion of revenue that is turned into operating profit

  • It is expressed as a percentage and calculated using the formula:

$\mathrm{Operating}\mathrm{profit}\mathrm{margin}=\frac{\mathrm{Profit}\mathrm{from}\mathrm{operations}}{\mathrm{Sales}\mathrm{revenue}}\times 100$

• Changes in the operating profit margin indicate how well managers are keeping indirect costs low or encouraging sales

  • A rising operating profit margin indicates increasing levels of sales revenue and/or falling overheads

  • A falling operating profit margin indicates lower sales revenue and/or rising overheads

Profit for the year margin 

• The profit for the year margin shows the proportion of revenue that is turned into profit for the year

  • It is expressed as a percentage and calculated using the formula

$\mathrm{Profit}\mathrm{for}\mathrm{the}\mathrm{year}\mathrm{margin}=\frac{\mathrm{Profit}\mathrm{for}\mathrm{the}\mathrm{year}}{\mathrm{Sales}\mathrm{revenue}}\times 100$

• Changes in the net profit margin indicate how well managers are keeping borrowing costs low, minimising the level of tax paid or encouraging sales

  • A rising net profit margin indicates increasing levels of sales revenue and/or lower tax or borrowing costs

  • A falling net profit margin indicates lower sales revenue and/or higher tax or borrowing costs