Mastering Income and Financial Position Statements
Mastering Income and Financial Position Statements
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Mastering Income and Financial Position Statements
What do you already know about income and financial position statements?
Learning Objective
At the end of the lesson, you will be able to;
complete statements of comprehensive income and financial position,
apply relevant adjustments,
and critically evaluate a business's performance.
Introduction to Financial Statements
Financial statements summarise a business’s performance and position.
The two major ones are the statement of comprehensive income and the statement of financial position.
Purpose of Statement of Comprehensive Income
This statement shows how much profit or loss a business makes over a period. It records sales, costs, and total profit.
Purpose of Statement of Financial Position
Also known as the balance sheet, it provides a snapshot of a business’s financial position at a specific moment, showing assets, liabilities, and net worth.
Statement Overview
Financial Position
Shows assets, total liabilities, and equity at the end of a period — a financial snapshot.
Measures trading position and profit over a specified period. Includes sales, direct costs, and all other expenses.
Comprehensive Income
Comprehensive Income - Terms
}Sales: Total value of goods or services sold to customers
}Sales Returns: Goods previously sold that have been returned by customers to the business
}Purchases: Total value of all goods bought by the business from their suppliers
}Purchases Returns: Goods that have been returned by the business to their suppliers
}Carriage Inwards: A charge made by suppliers for the delivery/transport related to goods bought by the business. It increases the overall cost of goods to the business
}Stock: Items bought by the business for resale. Stock can be described in 2 ways:
Opening Stock (Opening inventory): the value placed on all stock held at the start of a financial period
Closing Stock (Closing inventory): the value placed on the stock held in the business (both on shelves and in the stockroom) at the end of a financial period
Calculating Sales Revenue
Sales revenue = quantity sold × selling price.
This is the total money brought in by business activities before costs.
Cost of Goods Sold (COGS)
COGS Formula
COGS = opening inventories + purchases – closing inventories. Directly linked to goods actually sold.
Purpose
Calculates the actual cost of inventory used to generate sales, not just total goods purchased.
Question
A retail company started the year with £35,000 worth of inventory. During the year, they purchased an additional £50,000 in stock and paid £5,000 for shipping and raw materials. At the end of the year, they conducted a stocktake and found they had £10,000 worth of inventory left.
What is the company's total Cost of Sales for the year?
Answer: £80,000
Step 1: Calculate Total Inventory Available
Beginning Inventory: £35,000
New Purchases & Direct Costs: £50,000 + £5,000 = £55,000
Total: £35,000 + £55,000 = £90,000
Step 2: Subtract Unsold Stock
Total Available: £90,000
Ending Inventory: £10,000
Cost of Sales: £90,000 - £10,000 = £80,000
Gross Profit Calculation
Gross profit = sales revenue – cost of goods sold. Shows the surplus before other expenses.
Question
A bakery generated £150,000 in total sales over the year. Their beginning inventory was £5,000, they spent £40,000 on ingredients and packaging, and they ended the year with £2,000 worth of stock.
Calculate the bakery’s Gross Profit for the year.
Answer: £107,000
Step 1: Work out the Cost of Sales
First, find the cost of the goods actually sold:
(Beginning Inventory + Purchases) - Ending Inventory
(£5,000 + £40,000) - £2,000 = £43,000
Step 2: Subtract Cost of Sales from Revenue
Now, take the total money coming in and subtract that cost:
Total Revenue: £150,000
Cost of Sales: - £43,000
Gross Profit: £107,000
Question
A tech gadget store sells 400 custom headphones in one month at a price of £150 each.
The store buys these headphones from a supplier for £60 each.
The store pays £5 per unit for custom packaging and delivery to the customer.
Monthly rent for the shop is £2,000, and staff salaries are £3,000 (these are fixed costs and are not included in Gross Profit).
BBC +2
Calculate the store's total Gross Profit for the month.
Answer: £34,000
1. Calculate Total Sales Revenue
Multiply the number of units sold by the selling price. 400 units x £150 Total Revenue = £60,000
2. Calculate Total Cost of Sales
Add all direct variable costs associated with making or buying those 400 units.
Purchase cost: 400 units x £60 = £24,000 Packaging/Delivery: 400 units x £5 = £2,000 Total Cost of Sales = £26,000 (Note: Shop rent and salaries are ignored as they are "overheads" or fixed costs)
3. Final Calculation
Subtract the direct costs from the revenue. £60,000 (Revenue) - £26,000 (Cost of Sales) Gross Profit = £34,000
Gross Profit Margin
To find the Gross Profit Margin, you express the Gross Profit as a percentage of the total Sales Revenue. This shows how much of every £1 earned is profit before other bills are paid.
Calculate the Gross Profit Margin for the Headphone Store.
Calculation for the Headphone Store
Using the figures from the previous example:
Gross Profit: £34,000 Sales Revenue: £60,000
Step 1: Divide Gross Profit by Revenue
£34,000 ÷ £60,000 = 0.5666...
Step 2: Convert to a Percentage
0.5666
100 = 56.67%
This means that for every £1 the store takes in sales, it keeps roughly 57p as gross profit, while 43p goes directly toward the cost of the headphones and packaging.
WHY IS THIS IMPORTANT FOR THE BUSINESS?
Profit or Loss for the Year
Profit for the year = gross profit – expenses + other income. This is the final figure before tax.
To get from Gross Profit to Net Profit, subtract Operating Expenses ( overheads)
These are the costs of running the business that don't change based on how many individual items you sell.
Common Expenses to Subtract:
Premises Costs: Rent, business rates, water, and electricity.
Staff Costs: Salaries, wages, and employer insurance (excluding direct production labour).
Marketing: Advertising, website hosting, and social media promos.
Administration: Office supplies, phone bills, internet, and insurance.
Finance & Legal: Bank fees, interest on loans, and accountant fees.
Depreciation: The loss in value of assets like machinery or vehicles over time.
The Net Profit Calculation -Headphone Store
From the previous example, the store had a Gross Profit of £34,000. Now we apply the "hidden" fixed costs mentioned earlier:
Gross Profit: £34,000
Less Rent: – £2,000
Less Salaries: – £3,000
Total Operating Expenses: £5,000
Net Profit Calculation:
£34,000 (Gross Profit) - £5,000 (Expenses) = £29,000
Activity
A customized surfboard builder sells 50 boards in a season for £800 each.
They started with £5,000 in fiberglass and foam. They bought another £12,000 in materials and spent £1,000 on specialist resin. At the end of the season, they had £2,000 of materials left in the workshop. Their other costs included £4,000 for workshop rent, £500 for a website subscription, and £1,500 for workshop insurance.
Calculate COS, GP, GP%, and NP.
Calculations
COS (Cost of Sales)
(£5,000 beginning stock + £13,000 purchases) - £2,000 ending stock = £16,000
GP (Gross Profit)
£40,000 total revenue (50 x £800) - £16,000 COS = £24,000
GP% (Gross Profit Margin)
(£24,000 GP / £40,000 Revenue) x 100 = 60%
NP (Net Profit)
£24,000 GP - £6,000 expenses (£4,000 + £500 + £1,500) = £18,000
Depreciation Methods
Depreciation spreads the cost of fixed assets over their useful life. It's included as an expense to realistically value assets.
Reduces asset value by a fixed amount each year. E.g., (£16,000-£4,000)/4 = £3,000/year.
Straight-Line
Reducing Balance
Reduces asset value by a fixed percentage yearly. E.g., 20% of remaining value each year.
Example: Calculating Depreciation
A courier company buys a new electric van for £30,000. They plan to keep it for 5 years, after which they expect to sell it for £5,000.
The Question
Calculate the annual depreciation charge using the straight-line method. Then, calculate the depreciation for the first two years using the reducing balance method at a rate of 20%.
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Complete the activity on the high-end bicycle manufacturer
Transferring Profit and Retained Profit
After tax, profits may be distributed as dividends or drawings or retained in the business. Retained profit is transferred to the statement of financial position.
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Adjustment: Prepayments and Accruals
Prepayments are expenses paid in advance; accruals are expenses paid after use. These ensure expenses match the correct period.
Review the Balance Sheet handout
Prepayments vs Accruals
Prepayments
Expense used in period but paid later. Recorded as a current liability.
Expense paid before the period used. Recorded as a current asset.
Accruals
Evaluating Business Performance
Analyse income statements by comparing profit percentages, year-on-year changes, and benchmarking against competitors.
Nordic Furniture Company Activity
Types of Analysis
Investors and creditors use statements to inform lending, investing, or offering credit.
Internal
Management uses analysis to measure business performance and guide decision making.
External
Internal Analysis (Operational Efficiency)
Production Efficiency (GP Margin: 55.67%):
For every £1 of sales, the company keeps nearly 56p. This is a strong margin for a manufacturing business, suggesting that the Cost of Sales (£133,000) is well-controlled.
The business has high "value-add," meaning the labour and design put into the bespoke desks justify a high price point compared to the cost of timber.
Overhead Control (Expense Ratio):
Operating expenses (£112,000) consume 37% of total revenue.
Wages (£62,000) are the largest drain on profit. Management should monitor if these costs are fixed or if they scale with production. If they are fixed, increasing sales volume will rapidly improve the NP margin.
Asset Management:
The business is heavily invested in Fixed Assets (£109,000). The use of Reducing Balance depreciation for machinery (£15,000) suggests they acknowledge the machinery loses value fastest in its early years. This reduces profit now but protects it in later years.
External Analysis (Stakeholder Perspective)
Liquidity & Solvency (The Current Ratio):
Current Assets (£46,000) ÷ Current Liabilities (£13,000) = 3.53:1.
External lenders (like banks) would see this as very safe. The company has £3.53 in short-term assets for every £1 of debt. They are in no danger of failing to pay the tax man or their staff.
Investment Attractiveness (Net Profit Margin: 14.67%):
After all bills and taxes, the "bottom line" is 14.67%. For an external investor, this is a respectable return.
However, the Drawings (£10,000) represent nearly 23% of the profit after tax. Investors might prefer to see that money "Retained" in the business to buy more machinery rather than being taken out by the owner.
Risk Profile:
The Accruals (£2,000) and Tax Owed (£11,000) are looming liabilities. While the cash position (£25,000) covers them easily, any sudden drop in sales would make the high rent (£24,000) and wage bill a significant risk, as these are likely fixed costs that cannot be easily cut.
Summary Statement
Nordic Furniture Co. is a high-margin, liquid business with strong internal controls. It is currently "owner-led," as evidenced by the drawings, but it has the financial stability to secure external funding for expansion if needed.
Considering Profit Quality
Profit quality refers to how sustainable and repeatable a profit is. One-off events may distort true business performance.
Window Dressing in Accounts
Window dressing means manipulating financial information to appear more favourable. Always consider the accuracy and reliability of statements.
Summary of Key Concepts
You can now complete both the statement of comprehensive income and financial position, make adjustments, and evaluate business results.
Check Your Understanding
Can you explain the difference between COGS and expenses?
How do prepayments and accruals affect statements?
Write down 3 things you learned in this lesson.
Write down 2 things you want to know more about.
Ask 1 question about something you haven't quite understood yet.
