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Cambridge IGCSE0450

Income statements

Business Studies 0450 Chapter Notes

What this chapter covers

Income statements - What profit is and why it is importantIncome statements - Income statements
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In this chapter

  1. 1How a profit is made
  2. 2Profit as a reward for risk-taking
  3. 3Profit as a source of finance
  4. 4Profit and cash are different
  5. 5Why a profitable business can run short of cash
  6. 6What an income statement shows
  7. 7Gross profit and profit
  8. 8Cost of sales and expenses
  9. 9Retained profit
  10. 10Using income statements to decide

1. How a profit is made

Profit is the difference between total revenue and total costs. Revenue is the money a business earns from its sales.

A business makes a profit when revenue is greater than costs. It makes a loss when costs are greater than revenue. When the two are equal it breaks even: no profit and no loss.

profit = total revenue - total costs

total revenue = price × quantity sold

Examiner insight

“Some answers lacked precision by referring to costs rather than total costs.” “Other common mistakes included confusing the term with revenue or gross profit.”

Worked example 12 marks

Kiran's Bakery sold 2000 loaves at textdollar3 each in May. Its total costs for May were textdollar4500. Calculate the profit of Kiran's Bakery for May.

  1. 1

    Knowledge: profit = total revenue − total costs [1]

  2. 2

    Application: revenue = 2000 × 3 = textdollar6000, so profit = 6000 - 4500 = textdollar1500 [1]

2. Profit as a reward for risk-taking

A private sector business is owned by individuals, not the government. The owner puts in money and time, and could lose both if the business fails.

Profit is the reward for risk-taking and enterprise. It is the owner who is rewarded, not the employees.

Examiner insight

“The first option also had repetition of the question with candidates saying profit was a reward for risk taking as they had taken a risk and therefore deserved a reward.” “Weaker candidates also seemed to be confused over who was getting the reward and spoke of the reward for employees.”

Worked example 14 marks

Zara used textdollar40 000 of her own savings to open Zara Textiles, a small private company that makes school uniforms. Explain why profit is important to Zara.

  1. 1

    Knowledge: profit is the reward for the owner's risk-taking and enterprise [1]

  2. 2

    Application: Zara risked textdollar40 000 of her own savings on the business [1]

  3. 3

    Analysis: a higher profit means her savings earn her a return for that risk [1]

  4. 4

    Analysis: with no profit the risk was not worth taking, so she may close the business [1]

3. Profit as a source of finance

Profit that is kept in the business is retained profit. It is a source of finance: the owner can reinvest it to pay for new equipment or expansion.

Retained profit has no interest to pay, unlike a bank loan. A new business has not yet made profit, so it cannot use this source.

Examiner insight

“Source of finance was often described as necessary to pay operating costs rather than to finance investment.” “Using retained profit was often identified as having no interest needing to be paid and some candidates identified its opportunity cost.”

Worked example 12 marks

Zara Textiles made a profit of textdollar12 000 last year. Explain one way Zara could use this profit to help the business grow.

  1. 1

    Knowledge: she can reinvest the retained profit as a source of finance [1]

  2. 2

    Application: she could put the textdollar12 000 towards new sewing machines to make more uniforms, with no loan interest to pay [1]

4. Profit and cash are different

Profit is what is left when total costs are taken from total revenue. Cash is the money the business actually has. It comes in as cash inflows and goes out as cash outflows.

Profit can be reinvested to grow the business. Cash is needed to pay day-to-day costs, such as wages and supplies, and for emergencies.

Examiner insight

“The strongest answers explained that profit could potentially be reinvested to increase growth while cash is vital for paying day to day costs.” “A mistake made by the weakest answers was to state that profit was used to pay wages and raw materials.”

Worked example 16 marks

Kiran's Bakery made a profit of textdollar1500 in May and holds textdollar800 in the bank. Explain why both profit and cash are important to the bakery.

  1. 1

    Knowledge: profit is total revenue minus total costs [1]

  2. 2

    Application: the textdollar1500 profit can be reinvested in a second oven [1]

  3. 3

    Analysis: more loaves can be baked, so the business grows [1]

  4. 4

    Knowledge: cash is needed to pay day-to-day costs [1]

  5. 5

    Application: the textdollar800 pays this week's flour and wages [1]

  6. 6

    Analysis: without cash, suppliers and staff go unpaid despite the profit [1]

5. Why a profitable business can run short of cash

Revenue is not cash. A sale adds to revenue when it is made, but the cash arrives only when the customer pays. A customer who is slow to pay reduces cash inflows.

Some cash inflows are not profit at all. Money received from a bank loan is a cash inflow, but it is not profit.

A cash flow forecast shows cash inflows and outflows. It does not show profit or loss.

Examiner insight

“A common misunderstanding was to assume revenue is the same as cash.” “A common mistake was to refer to profit which is not a cash inflow.”

Worked example 14 marks

Kiran's Bakery made a profit of textdollar1800 in June, but its bank balance fell to textdollar200. A café owes the bakery textdollar2000 for June deliveries. A flour bill of textdollar900 is due this week. Explain why Kiran's Bakery has a cash problem even though it made a profit.

  1. 1

    Knowledge: revenue is counted when the sale is made, but cash comes in only when the customer pays [1]

  2. 2

    Application: the café's textdollar2000 is part of June revenue but has not been paid [1]

  3. 3

    Analysis: so cash inflows are low, and the bank balance of textdollar200 is far below the profit [1]

  4. 4

    Analysis: the bakery cannot pay the textdollar900 flour bill, so the supplier may stop deliveries [1]

Recap

  • Profit = total revenue − total costs. Revenue is not profit. Profit is not cash.
  • Profit rewards the owner for risk-taking and enterprise. Name the owner, not the employees.
  • Retained profit is a source of finance. It pays for investment and has no interest to pay.
  • Profit can be reinvested to grow. Cash pays day-to-day costs and covers emergencies.
  • A profitable business can run short of cash if customers pay late. A loan is a cash inflow, not profit.

6. What an income statement shows

An income statement is a financial document. It shows the revenue of a business and its costs over a period of time, and so the profit it made. It does not show cash coming in and going out.

It lists revenue, the money from sales, then cost of sales, the cost of the goods the business sold. After that come the expenses, such as rent and salaries. The last lines give profit and retained profit.

Examiner insight

“Some candidates thought, incorrectly, that cost of sales was price.” “A common mistake was to identify elements of an income statement such as revenue, profit or costs rather than identifying the cash inflow or outflow.”

Worked example 12 marks

Hana owns Bright Bakes, a small bakery that sells cakes to local cafés. Explain what is meant by ‘cost of sales’ for Bright Bakes.

  1. 1

    Knowledge: cost of sales is the cost of the goods a business sells. [1]

  2. 2

    Application: for Bright Bakes this is the flour, sugar and butter bought for the cakes it sold. [1]

7. Gross profit and profit

Gross profit is revenue minus cost of sales. It shows what the business earns on the goods it sells, before any expenses.

Profit is revenue minus total costs. On an income statement, take the expenses from gross profit to reach it.

Always name your answer. A profit figure is not revenue and it is not gross profit.

gross profit = revenue - cost of sales

profit = gross profit - expenses

profit = revenue - total costs

Examiner insight

“Most candidates were able to calculate the value for cost of sales but very few understood that expenses were a negative value.” “However, whilst the calculations were correct, weaker candidates mistakenly labelled profit as gross profit or even revenue.”

Worked example 14 marks

Pixel Print makes posters for schools. Its income statement for 2025 is below. Calculate the gross profit and the profit of Pixel Print.

2025 ($)
Revenue120 000
Cost of sales72 000
Gross profit?
Expenses30 000
Profit?
  1. 1

    Knowledge: gross profit = revenue − cost of sales. [1]

  2. 2

    Application: gross profit = char"24 120 000 - char"24 72 000 = char"24 48 000. [1]

  3. 3

    Knowledge: profit = gross profit − expenses. [1]

  4. 4

    Application: profit = char"24 48 000 - char"24 30 000 = char"24 18 000. [1]

8. Cost of sales and expenses

Cost of sales is the cost of the goods sold, such as raw materials bought to make them. Expenses are the running costs of the business, such as rent and salaries.

The split matters. Cost of sales comes off revenue first, to give gross profit. Expenses come off later, so they change profit but not gross profit.

A lower gross profit can be caused by lower demand and a higher cost of sales. A higher rent does not touch it.

Examiner insight

“The most common mistake was to include examples from cost of sales, notably purchasing raw materials.” “A common mistake was to assume that expenses including rent and salaries would have an impact on gross profit.”

Worked example 14 marks

Greenleaf Furniture makes wooden chairs. Its gross profit fell from char"24 50 000 to char"24 38 000 in 2025. Explain two reasons why the gross profit of Greenleaf Furniture may have fallen.

  1. 1

    Knowledge: lower demand. [1]

  2. 2

    Application: Greenleaf sold fewer wooden chairs, so its revenue fell while each chair cost the same to make. [1]

  3. 3

    Knowledge: a higher cost of sales. [1]

  4. 4

    Application: the timber Greenleaf buys cost more, so more was taken off revenue to reach the char"24 38 000. [1]

9. Retained profit

Retained profit is the profit kept in the business. It is what is left of profit after tax and any dividends paid to shareholders.

A business can use retained profit to grow. It is a source of finance with no interest to pay.

A new business has none, because it has not yet made profit to keep.

retained profit = profit - tax - dividends

Examiner insight

“Some ignored the fact that this was a new business and therefore did not have access to some sources such as retained profits.”

Worked example 14 marks

Peak Gear is a private limited company that sells climbing equipment. Omar is its main shareholder. In 2025 its profit was char"24 25 000. Tax was char"24 4 000 and dividends were char"24 8 000. Calculate the retained profit of Peak Gear and explain one way the company could use it.

  1. 1

    Knowledge: retained profit is profit left after tax and dividends. [1]

  2. 2

    Application: char"24 25 000 - char"24 4 000 - char"24 8 000 = char"24 13 000 retained profit. [1]

  3. 3

    Application: Peak Gear could spend it on new stock of climbing equipment or on shop fittings. [1]

  4. 4

    Analysis: this needs no loan, so Peak Gear pays no interest. [1]

10. Using income statements to decide

Decisions rest on profit calculations. Work out gross profit and profit for each option or each year, then compare them.

A comparison is not enough. Explain why a figure changed, for example revenue rose but cost of sales rose by more. Use the numbers from the business.

End with a clear decision and a supporting reason. A decision alone, or a summary of the earlier points, is not evaluation.

Examiner insight

“However, there were some candidates who knew how to carry out the calculations and could make basic interpretations of an income statement but did not have the more detailed understanding of the causes behind the changes in figures.” “This was reinforced by weaker answers which assumed that an increase in the cost of sales was a benefit to the business.”

Worked example 18 marks

Zara owns Lakeside Café. She wants to use her profit to open a second café. Her income statements for the last two years are below. Advise Zara whether she should open a second café now.

2024 ($)2025 ($)
Revenue150 000180 000
Cost of sales60 00081 000
Gross profit90 00099 000
Expenses70 00085 000
Profit20 00014 000
  1. 1

    Knowledge: profit is gross profit minus expenses, so both lines decide whether Zara can afford to expand. [1]

  2. 2

    Application: gross profit rose from char"24 90 000 to char"24 99 000, but profit fell from char"24 20 000 to char"24 14 000. [1]

  3. 3

    Application: revenue rose by char"24 30 000 while expenses rose by char"24 15 000. [1]

  4. 4

    Analysis: cost of sales rose by char"24 21 000, more than two thirds of the extra revenue, so gross profit rose by only char"24 9 000. [1]

  5. 5

    Analysis: expenses rose by char"24 15 000, more than the char"24 9 000 gain in gross profit, so profit fell by char"24 6 000. [1]

  6. 6

    Analysis: less profit means less retained profit to pay for a second café. [1]

  7. 7

    Evaluation: Zara should wait, because the café now earns less profit on more sales. [1]

  8. 8

    Evaluation: she should first find out why expenses rose, as a one-off cost would change the decision. [1]

Recap

  • An income statement shows revenue, cost of sales, gross profit, expenses, profit and retained profit.
  • Gross profit = revenue − cost of sales.
  • Profit = gross profit − expenses, or revenue − total costs.
  • Cost of sales is the cost of the goods sold. Expenses are running costs such as rent and salaries.
  • Retained profit is profit kept in the business after tax and dividends. It has no interest to pay.
  • Decide with calculations, explain why the numbers changed, then give a decision and a reason.
  • Name every answer: profit, gross profit and revenue are three different numbers.

End-of-chapter exercise

Test yourself on the whole chapter. Work through these before moving on.

  1. Define 'profit'.2 marks
  2. Hasan's Cycle Repairs had total revenue of textdollar8400 and total costs of textdollar9100 in March. Calculate the profit or loss for March.2 marks
  3. Identify two reasons why profit is important to a private sector business.2 marks
  4. Mina's Pottery sold 350 mugs at textdollar12 each last month. Its total costs were textdollar2600. Calculate its profit. Then calculate the profit if the price rises to textdollar14 and the quantity sold stays the same.4 marks
  5. Omar left his job and used textdollar25 000 of his savings to open Omar's Garage, a private car repair business. Explain why profit is important to Omar.4 marks
  6. Lopez Bakery made a profit of textdollar18 000 and wants a textdollar15 000 oven to bake more bread. Explain how profit can help Lopez Bakery to buy the oven.4 marks
  7. Delta Print made a profit of textdollar5000 last month. Its bank balance is textdollar300. Its customers take 60 days to pay, and it must pay textdollar1800 of wages on Friday. Explain why Delta Print has a cash problem despite its profit.6 marks
  8. Amina's Cafe made a profit of textdollar9000 this year. Explain why profit and cash are each important to Amina's Cafe.6 marks
  9. Tariq owns Tariq's Tours, a private business running coach trips. In June its total revenue was textdollar14 000 and its total costs were textdollar16 500. All June sales and all June costs were paid in cash in June. Tariq also received a bank loan of textdollar10 000 in June. The bank balance rose from textdollar2000 to textdollar9500. Tariq says: 'My bank balance went up, so June was a profitable month.' Use the figures to explain why Tariq is wrong, and why this matters to him as the owner.8 marks
  10. Sunita owns Sunita's Spices, a private business selling jars of spices to restaurants. It made a profit of textdollar11 000 this year. Its bank balance is textdollar3000. A supplier bill of textdollar2500 is due next week. Restaurants owe Sunita textdollar9000, due in 30 days. A packing machine costs textdollar8000 and would double the jars packed each day. Sunita says: 'I made textdollar11 000 profit, so I can pay for the machine today.' She could buy it now with a bank loan, or wait 30 days and use retained profit. Which should she choose? Justify your answer.12 marks
  11. Define ‘gross profit’.2 marks
  12. Mira runs a juice bar. Last year its revenue was char"24 40 000 and its cost of sales was char"24 15 000. Calculate the gross profit.2 marks
  13. A bakery’s costs are: flour bought for bread, shop rent, a manager’s salary and butter bought for pastries. Identify two of these that are expenses.2 marks
  14. Tolu runs a bike repair shop. Revenue was char"24 90 000 and cost of sales was char"24 54 000. Expenses were rent char"24 12 000, wages char"24 15 000 and other costs char"24 3 000. Calculate the profit.4 marks
  15. Sita’s Bakery is a private limited company. It made a profit of char"24 60 000 and paid char"24 12 000 in tax and char"24 20 000 in dividends. Calculate the retained profit. Explain one advantage of using it to buy a new oven.4 marks
  16. Kofi’s printing business saw revenue rise from char"24 80 000 to char"24 95 000 while cost of sales rose from char"24 40 000 to char"24 42 000. Calculate the gross profit in each year and explain why it rose.4 marks
  17. Oakline makes furniture and can accept only one of two orders. Using the table, advise Oakline which order it should accept. | | Order A ($) | Order B ($) | | --- | --- | --- | | Revenue | 50 000 | 45 000 | | Cost of sales | 30 000 | 22 000 | | Expenses | 12 000 | 10 000 |6 marks
  18. Maple Toys’ revenue rose in 2025 but its profit fell. Using the table, analyse why the profit fell. | | 2024 ($) | 2025 ($) | | --- | --- | --- | | Revenue | 200 000 | 230 000 | | Cost of sales | 120 000 | 150 000 | | Expenses | 50 000 | 55 000 |6 marks
  19. Reef Divers runs scuba diving trips for tourists. Its manager says 2025 was the better year because revenue rose and she cut expenses. The table shows part of its income statements. Do you agree with the manager? Justify your answer. | | 2024 ($) | 2025 ($) | | --- | --- | --- | | Revenue | 240 000 | 276 000 | | Gross profit | 132 000 | 124 000 | | Profit | 42 000 | 40 000 |8 marks
  20. Priya owns Orbit Bikes, which makes bicycles. Last year revenue was char"24 300 000, cost of sales char"24 180 000 and expenses char"24 80 000. Option A: a new supplier cuts cost of sales by 15% but adds char"24 20 000 to expenses, with revenue unchanged. Option B: advertising adds char"24 35 000 to expenses, and revenue and cost of sales both rise by 25%. Recommend which option Priya should choose. Justify your answer.12 marks

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