The Income Statement (Profit and Loss) Explained
The income statement compares the income and expenses of one year. What is left is the profit or loss.
Updated
What does the income statement show?
The balance sheet shows balances on one date. The income statement (profit and loss account) shows the whole year: how much the business earned (income) and what it used up to earn it (expenses).
Income − Expenses = Profit (or Loss)
Example
| Item | Amount |
|---|---|
| Revenue | £200,000 |
| − Raw materials | £80,000 |
| − Staff costs | £60,000 |
| − Depreciation | £15,000 |
| − Other operating expenses | £20,000 |
| = Operating profit | £25,000 |
| − Finance costs | £5,000 |
| = Profit before tax | £20,000 |
By nature or by function
- By nature: expenses grouped by type (materials, staff, depreciation), plus the change in inventories of finished goods and work in progress.
- By function: cost of sales, distribution costs and administrative expenses.
- Both give the same profit; they only group the expenses differently.
Check yourself
Revenue £150,000, materials £60,000, staff £50,000, depreciation £10,000, interest £4,000. What is the profit before tax?
A business buys a machine for £40,000 from its bank account. How does that change the income statement that day?
More on accounting
Typical exam mistakes
- Treating an investment as an expense: a machine goes on the balance sheet, only the yearly depreciation is an expense.
- Confusing cash received with income: a new loan brings cash but no income.
- Forgetting the change in inventories when expenses are classified by nature.
Your turn
Three transactions from the journal entry trainer: choose the accounts, enter the amounts and check.
Transaction
A customer buys goods for £80.00 plus 20% VAT and pays in cash.
Debit
Assets up · expenses · liabilities down
Total debit£0.00
Credit
Liabilities up · income · assets down
Total credit£0.00
Frequently asked questions
What is the difference between profit and cash flow?+
Profit comes from income and expenses, cash flow from money in and out. Depreciation lowers profit but costs no cash; a loan brings cash but no profit.