5.3: Income Statements Notes:

Why Accounts Are Necessary

• Businesses must keep accurate financial records to track sales, purchases, debts, and cash.

• Without accounts, a business may forget debts owed, over‑order materials, run out of cash, or face tax penalties.

• Final accounts show profit/loss and business worth at year end.

• Limited companies must publish accounts by law.

How Profit Is Made

• Profit = Revenue − Cost of making products

• Profit increases by:

  • Raising revenue faster than costs.

  • Reducing costs.

  • Doing both.

Why Profit Is Important

• Reward for enterprise - Entrepreneurs are rewarded for effort and creativity.

• Reward for risk‑taking - Investors take risks; profit compensates them (e.g., dividends).

• Source of finance - Retained profit funds expansion.

• Indicator of success - High profits attract new investment; losses discourage entry.

Profit vs Cash

• Profit ≠ cash.

• A business can show profit but have no cash (e.g., selling on credit, paying suppliers early).

• Cash flow problems can occur even when profitable.

Key Definitions

• Income statement: shows income, costs, and profit/loss over a period.

• Revenue: income from selling goods/services.

• Cost of sales: direct costs of goods sold (materials + direct labor).

• Gross Profit = Revenue − Cost of Sales

• Net Profit = Gross Profit − Expenses

• Retained Profit = Net Profit − Tax − Dividends

Trading Account Section

• Shows:

  • Revenue

  • Cost of sales

  • Gross profit

Full Income Statement Structure

Using Income Statements in Decision‑Making

• Managers use income statements to:

  • Compare performance with last year.

  • Compare with competitors.

  • Identify falling profits and reasons.

  • Decide between product options or locations.

  • Forecast profitability of new ideas.

NOTES DONE BY FARIDA SABET

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