5.3. Profit and loss

Learning objectives

5.3.1What is profit and why it is important• what profit is• importance of profit to private sector businesses: reward for risk-taking, source of finance, measure of success, attract investors 5.3.2Statement of profit or loss• main features of a statement of profit or loss: revenue, cost of sales, gross profit, expenses, profit• make simple calculations based on a statement of profit or loss: revenue, cost of sales, gross profit, expenses, profit• make decisions based on simple statements of profit or loss Note: candidates will not be assessed on constructing statements of profit or loss.

Profit is the amount left when a business subtracts all its costs from its revenue for a period. It is not the same as revenue, and it is not the same as cash available on a particular day.

\text{profit}=\text{revenue}-\text{total costs}

Why profit matters	Business mechanism
reward for risk-taking	compensates owners or shareholders for committing money, time and enterprise when success was uncertain
source of finance	retained profit can fund assets, expansion or product development without new borrowing or ownership
measure of success	changes in profit help assess products, managers or the business over time, although context and scale still matter
attract investors	a credible profit record can make future returns appear more likely and help a company raise equity finance

A high profit figure alone does not prove that cash flow is healthy or that every product succeeds. Use profit with the time period, business size and supporting financial information before judging performance.

A statement of profit or loss summarises financial performance over a period. Revenue is reduced first by cost of sales to find gross profit, then by expenses to find profit. Each subtotal answers a different management question.

\text{gross profit}=\text{revenue}-\text{cost of sales}\text{profit}=\text{gross profit}-\text{expenses}

Feature	Meaning and useful rearrangement
revenue	income from sales; $\text{revenue}=\text{gross profit}+\text{cost of sales}$
cost of sales	cost of producing or buying the goods sold; $\text{cost of sales}=\text{revenue}-\text{gross profit}$
gross profit	amount left after cost of sales, before expenses
expenses	other operating costs; $\text{expenses}=\text{gross profit}-\text{profit}$
profit	final amount after cost of sales and expenses

Worked comparison: Company A has revenue $100m and cost of sales$ 40m, so gross profit is $60m. If expenses are$ 40m, profit is $20m. Company B has revenue$ 200m, cost of sales $90m and expenses$ 60m, giving gross profit $110m and profit$ 50m. B earns more profit, while A converts a larger share of revenue into gross profit; the decision depends on the buyer's aim and acquisition cost.

Use the statement to identify whether a change comes from sales, cost of sales or expenses; compare performance with earlier periods or another business; test whether a product or operation should continue; and support investment or finance decisions. State the calculation, explain what it shows, then add the contextual limitation before recommending.

You must calculate and decide from a supplied statement, but you are not assessed on constructing a complete statement from a blank page. A larger business may show more profit simply because it has more revenue, so raw totals are not always enough for comparison.

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