Statement of Profit or Loss

Introduction to the statement of profit or loss

Introduction to the statement of profit or loss

• A statement of profit or loss records the income and costs of a business incurred over a period of time (usually one year)

  • The statement is also known as an income statement

• Theprofit or loss statement identifies

  • Revenue

  • Cost of sales

  • Gross profit

  • Expenses

  • Operating profit (often known, simply, as profit)

• The extract from the statement for Toys and Trikes PLC shows figures for both 2022 and 2023, which enables year-on-year comparisons to be made

Profit or loss statement for Toys and Trikes Ltd

Features of the statement of profit or loss

Features of the statement of profit or loss

Sales revenue

• This is money generated through selling goods and services

  • Calculated by Price x Quantity

Cost of sales

• The cost of producing or buying in the goods sold by the business during a time period

  • They include the costs of raw materials, components, labour and packaging used to produce goods

Gross profit

• Gross profit is made when revenue is greater than the cost of sales

  • Calculated by Sales revenue - Cost of sales

Expenses

• Expenses are all of the other costs incurred by a business that are not directly related to each unit of output

  • Examples include rent, salaries and utilities

Operating profit

• This is profit made by a business after all costs have been deducted from revenue

  • Calculated by Gross profit - Expenses

Decisions based on the statement of profit or loss

Decisions based on the statement of profit or loss

• Profit or loss statements inform managers whether the business is making a profit or loss

  • They allow the comparison of performance to previous years, aid with future forecasts and can be used to make comparisons with competitors

• Finance managers are able to interrogate the data in order to make beneficial changes or set new strategic objectives

If the business is making a profit

• Is the profit higher or lower than last year?

  • If higher, what has the business done that could have led to this?

    • For example, finding a cheaper supplier of raw materials or increasing sales due to a new promotional campaign

  • If lower, why is profit falling? 

    • Have costs increased, such as higher energy bills for the premises, or have sales fallen due to a new competitor entering the market?

  • Is the profit higher or lower than that of competitors?

    • If lower, what can be done to become as profitable as other businesses?

    • For example, does the business need to improve the quality of the products or increase the product portfolio?

If the business is making a loss

• Is this a short-term or long-term problem?

  • Lower profits may be a result of an external shock affecting all businesses, such as the 2020 Covid pandemic, in which many businesses had to close or reduce working hours

  • Some losses may be more long-term

    • For example, ecommerce growth has led to many high-street stores closing down as the number of customers has dwindled

  • Are competitors making losses?

    • If they are, the business needs to consider whether the industry is changing to the point that it may become extinct

    • Alternatively, it needs to ask tough questions about what can be done to evolve with changing market conditions