Income statement: the two-step chain
An income statement (profit and loss account) reports performance over a trading period, top to bottom: revenue (price × quantity); minus cost of goods sold (COGS) = gross profit; minus expenses (overheads: rent, salaries, marketing) = profit for the year. Two formulas: gross profit = revenue − COGS; profit for the year = gross profit − expenses (= revenue − total costs). The chain: Revenue − COGS = Gross; Gross − Expenses = Net.
Why profit matters
Profit = revenue − total costs. It is NOT revenue (money in before costs), NOT cash flow, and NOT the pot that pays day-to-day wages and bills. Why it matters: reward for the owner's risk; a source of internal finance (retained profit funds investment without borrowing); a signal to lenders and shareholders that the firm is healthy; survival — persistent losses lead to insolvency.
Profit: retained vs distributed
Once profit for the year is found, the firm decides how to use it. Retained profit stays in the business as internal finance — for investment, repaying debt, or reserves; no interest, no dilution of ownership, but only if profitable. Distributed profit goes to owners: drawings for a sole trader, dividends for a company. Most firms do both. Retained profit funds investment, not routine bills (those are paid from cash).
Drawn from real examiner reports.
Revenue is not profit
The most frequent 5.3 error: treating revenue and profit as the same. Revenue (turnover) = price × quantity — money in BEFORE any costs; profit = revenue − total costs. A firm with high revenue can still make a loss. In a 2-mark define, 'money from sales' earns one mark; the second needs the VALUE of sales. 'Revenue is the profit' scores zero.
June 2022 P13 Q2(a)
Gross margin vs profit (net) margin
Both margins divide by revenue; only the numerator differs. Gross profit margin = gross profit ÷ revenue × 100 (after COGS only). Profit margin (net) = profit for the year ÷ revenue × 100 (after ALL costs). Candidates swap them, getting a number but the wrong ratio. Hook: Gross on top = gross margin; Net on top = net margin.
November 2022 P12 Q2(b); November 2023 P13 Q2(b)
Rising gross profit can hide a falling margin
Candidates note that gross profit rose but miss that COGS grew faster than revenue. If revenue rises 15% but COGS rises 25%, the gross profit MARGIN falls even though absolute gross profit is higher — the firm keeps less per pound of sales, a cost-control warning. A full answer discusses the RATIO, not just the cash figure.
June 2023 P23 Q4(b)
Profit does not pay routine bills
A misconception across all four sittings: that profit pays day-to-day wages, rent and bills, or that retained profit covers operating costs. Those are paid from CASH during the year and are already deducted before profit is calculated. Profit is the surplus AFTER all costs; retained profit is used for investment or reserves, not for routine expenses.
November 2023 P12 Q4(c); November 2023 P23 Q4(b)
Do not read revenue as the profit line
When reading an income statement, candidates label the revenue figure as 'profit'. Revenue is the TOP line and the largest figure — the total value of sales before any deduction. Profit for the year is the BOTTOM line, after COGS and expenses. Never quote the revenue number as if it were profit; identify each line by its position and formula.
June 2022 P23 Q3(b)
Divide a margin by revenue, not COGS
A margin is always a percentage OF revenue, so revenue is the denominator in both margin formulas. Candidates sometimes divide by COGS instead — both figures sit in the income statement, which makes the wrong one tempting. Gross profit margin = gross profit ÷ revenue × 100; profit margin = profit for the year ÷ revenue × 100. The denominator is revenue every time.
Justify needs a supported judgement
On a 6-mark 'Justify' question, AO4 needs a supported judgement, not a balanced summary: decide, then give the reason one side outweighs the other in the firm's context. A conclusion of 'it depends', with no decision, cannot earn AO4.
Process the figures, then use them
In data-response parts, process the figures, do not copy them. Calculate gross profit, profit and the margins (Level 2), then USE those results to support a judgement (Level 3). Quoting numbers without processing them stays at knowledge marks.
Match the profit figure to the command
Read which profit the question wants before calculating. 'Gross' = revenue − COGS; 'profit for the year' is after expenses too. For margins, check gross vs net and divide by revenue. Label the answer with the right term and % or money units.
An income statement (also called a profit and loss account) records a business's financial performance over a trading period (usually one year). It shows whether the business has made a profit or a loss by comparing its revenue with all its costs.
| Line | Formula |
|---|---|
| Revenue (sales revenue / turnover) | selling price × quantity sold |
| minus Cost of goods sold (COGS) (cost of sales) | direct costs of the goods/services sold |
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