What you'll learn
- Why businesses produce financial statements and how they support decisions.
- The main parts of an income statement and a statement of financial position.
- The difference between assets and liabilities, including why one statement is a “snapshot”.
- How to calculate and interpret gross profit margin and net profit margin.
Why financial statements matter
Financial statements
Financial statements are formal documents that summarise a business’s financial performance and financial position. They help owners, managers, lenders and other stakeholders judge how well the business is doing.
A business needs financial statements because “we made some sales” is not enough detail. A business might have high sales revenue but still make little profit if its costs are too high.
Financial statements help a business make decisions such as:
- whether to expand into a new location
- whether to cut costs or raise prices
- whether it can afford more staff
- whether a bank should lend it money
- whether investors should put money into the business
Stakeholder
A stakeholder is anyone with an interest in the actions and performance of a business, such as owners, employees, customers, suppliers, lenders and the government.
Performance needs evidence
In GCSE Business, you should not just say “the business is doing well”. Use financial evidence, such as profit, costs, sales revenue and profit margins, then explain what this means for the business.
The two main financial statements
For this topic, you need to identify the main components of:
- the income statement
- the statement of financial position
The income statement shows performance over a period of time, while the statement of financial position shows the business’s financial position at one specific date.
The income statement
Income statement
An income statement is a financial statement that shows a business’s sales revenue, costs and profit over a period of time, such as a month or a year.
The key parts are:
- Sales revenue: money received from selling goods or services.
- Cost of sales: the direct costs of making or buying the goods sold, such as ingredients for Greggs or stock bought by JD Sports.
- Gross profit: profit after subtracting cost of sales from sales revenue.
- Expenses: other running costs, such as rent, wages, advertising and electricity.
- Net profit: profit after subtracting all expenses from gross profit.
The basic calculations are:
Gross profit=sales revenue−cost of sales\text{Gross profit} = \text{sales revenue} - \text{cost of sales}Gross profit=sales revenue−cost of sales Net profit=gross profit−expenses\text{Net profit} = \text{gross profit} - \text{expenses}Net profit=gross profit−expensesBuilding an income statement
A local sole-trader café has sales revenue of £90,000. Its cost of sales is £32,000 and its expenses are £41,000.
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Calculate gross profit by subtracting cost of sales from sales revenue:
Gross profit=£90,000−£32,000=£58,000\text{Gross profit} = \text{£}90{,}000 - \text{£}32{,}000 = \text{£}58{,}000Gross profit=£90,000−£32,000=£58,000 -
Calculate net profit by subtracting expenses from gross profit:
Net profit=£58,000−£41,000=£17,000\text{Net profit} = \text{£}58{,}000 - \text{£}41{,}000 = \text{£}17{,}000Net profit=£58,000−£41,000=£17,000 -
Interpret the result: the café is profitable because it has £17,000 left after covering cost of sales and expenses.
Confusing gross profit and net profit
Gross profit only subtracts cost of sales. Net profit subtracts all expenses too, so it gives a fuller picture of whether the business is profitable overall.
The statement of financial position
Statement of financial position
A statement of financial position is a financial statement showing what a business owns and owes at one specific point in time.
This statement is a snapshot in time. That means it shows the position on one date, for example “as at 31 March 2026”. It does not show all the sales and costs across the year — that is the job of the income statement.
Assets
Asset
An asset is something valuable that a business owns or controls, such as cash, stock, equipment, vehicles or buildings.
Assets can help the business operate. For example, a delivery van helps a bakery deliver orders to customers.
Liabilities
Liability
A liability is something the business owes, such as a bank loan, an overdraft or money owed to suppliers.
Liabilities matter because they may need to be paid in the future. A business can look profitable but still be under pressure if it owes large amounts soon.
Classifying assets and liabilities
A small online clothing business has £4,000 cash, £12,000 of stock, a £7,000 bank loan and £2,500 owed to suppliers.
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Identify the assets: cash and stock are assets because the business owns or controls them. Total assets are £4,000 + £12,000 = £16,000.
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Identify the liabilities: the bank loan and amount owed to suppliers are liabilities because the business must pay them. Total liabilities are £7,000 + £2,500 = £9,500.
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Interpret the snapshot: at this date, the business owns £16,000 of assets and owes £9,500, so it appears to own more than it owes.
Snapshot check
If the statement says “as at” a certain date, think snapshot. If it covers a period such as “year ended”, think income statement.
Profit margins
A business may make more profit simply because it is larger. Profit margins help you compare performance more fairly because they show profit as a percentage of sales revenue.
Profit margin
A profit margin shows how much profit a business makes from each £1 of sales revenue, expressed as a percentage.
You must memorise the formulas because students will not be given formulae in the exam.
Gross profit margin
Gross profit margin
Gross profit margin is gross profit as a percentage of sales revenue. It shows how effectively the business turns sales into gross profit before expenses are deducted.
Formula to memorise:
Gross profit margin=gross profitsales revenue×100\text{Gross profit margin} = \frac{\text{gross profit}}{\text{sales revenue}} \times 100Gross profit margin=sales revenuegross profit×100A higher gross profit margin can suggest the business is buying stock cheaply, charging strong prices, or controlling direct production costs well.
Net profit margin
Net profit margin
Net profit margin is net profit as a percentage of sales revenue. It shows how much final profit is made from sales after all costs and expenses are deducted.
Formula to memorise:
Net profit margin=net profitsales revenue×100\text{Net profit margin} = \frac{\text{net profit}}{\text{sales revenue}} \times 100Net profit margin=sales revenuenet profit×100Net profit margin is often the more useful overall measure because it includes expenses such as rent, wages, marketing and energy bills.
Calculating profit margins
A local café has sales revenue of £100,000, cost of sales of £40,000 and expenses of £45,000.
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Calculate gross profit:
Gross profit=£100,000−£40,000=£60,000\text{Gross profit} = \text{£}100{,}000 - \text{£}40{,}000 = \text{£}60{,}000Gross profit=£100,000−£40,000=£60,000 -
Calculate net profit:
Net profit=£60,000−£45,000=£15,000\text{Net profit} = \text{£}60{,}000 - \text{£}45{,}000 = \text{£}15{,}000Net profit=£60,000−£45,000=£15,000 -
Calculate gross profit margin:
Gross profit margin=£60,000£100,000×100=60%\text{Gross profit margin} = \frac{\text{£}60{,}000}{\text{£}100{,}000} \times 100 = 60\%Gross profit margin=£100,000£60,000×100=60% -
Calculate net profit margin:
Net profit margin=£15,000£100,000×100=15%\text{Net profit margin} = \frac{\text{£}15{,}000}{\text{£}100{,}000} \times 100 = 15\%Net profit margin=£100,000£15,000×100=15% -
Interpret the results: for every £1 of sales revenue, the café keeps 60p as gross profit but only 15p as final net profit after expenses.
Using the wrong denominator
For both gross profit margin and net profit margin, divide by sales revenue, not by costs, expenses or profit.
Interpreting financial performance
Calculations only get you part of the way. The strongest answers explain what the numbers mean for the business in context.
You may be asked to judge performance by considering:
- current performance: is the business profitable now?
- previous years: is performance improving or worsening over time?
- competitors: is the business performing better or worse than rivals?
- stakeholders: who is affected, and how?
Judging performance using income statement data
A small bakery has the following results.
| Measure | Year 1 | Year 2 |
|---|---|---|
| Sales revenue | £120,000 | £150,000 |
| Gross profit | £72,000 | £80,000 |
| Net profit | £18,000 | £18,000 |
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Compare sales revenue: sales revenue increased by £30,000, from £120,000 to £150,000. This suggests the bakery sold more or charged higher prices.
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Compare net profit: net profit stayed the same at £18,000, so the extra sales did not lead to extra final profit.
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Calculate net profit margin for each year:
Year 1 net profit margin=£18,000£120,000×100=15%Year 2 net profit margin=£18,000£150,000×100=12%\begin{aligned} \text{Year 1 net profit margin} &= \frac{\text{£}18{,}000}{\text{£}120{,}000} \times 100 = 15\% \\ \text{Year 2 net profit margin} &= \frac{\text{£}18{,}000}{\text{£}150{,}000} \times 100 = 12\% \end{aligned}Year 1 net profit marginYear 2 net profit margin=£120,000£18,000×100=15%=£150,000£18,000×100=12% -
Make a judgement: performance is mixed. Sales and gross profit improved, but net profit margin fell from 15% to 12%, so expenses may be rising too quickly. The bakery may need to review costs such as wages, energy or rent.
Looking from different stakeholder perspectives
Different stakeholders may interpret the same figures differently.
Owners
Owners usually focus on profit and profit margins. If net profit margin is falling, owners may worry that the business is not controlling expenses.
Managers
Managers use financial statements to make decisions. For example, if cost of sales rises, operations managers might look for cheaper suppliers, while marketing managers might review pricing.
Employees
Employees may care about whether the business can afford wages, training or job security. A profitable business may be more likely to recruit or reward staff.
Lenders
Banks and other lenders want to know whether the business seems able to repay borrowing. They may look at profit and liabilities before agreeing to a loan.
Suppliers
Suppliers may want evidence that the business is stable and likely to pay invoices on time.
Use comparison, not just calculation
A margin by itself is useful, but it becomes much more powerful when compared with last year, a competitor, or the business’s objectives.
Making a balanced judgement
A good judgement does not rely on one figure alone. For example, Aldi might accept lower profit margins if its strategy is to offer low prices and win market share. A luxury clothing business might aim for higher margins because customers expect premium prices.
You should also think about non-financial information. A fall in net profit margin may be worrying, but if the business has invested in staff training, a new website or better equipment, profit might improve later.
Margins do not tell the whole story
Profit margins are useful, but they do not show everything. They do not explain customer satisfaction, product quality, staff motivation or future growth plans.
In the exam
- Start by identifying the relevant figure or formula, then calculate carefully with £ signs and percentages where needed.
- Interpret the result in context: explain what it means for that specific business, not just “good” or “bad”.
- Make comparisons where possible: current year vs previous year, business vs competitor, or the viewpoint of different stakeholders.
Check yourself
- Why is the income statement described as covering a period of time?
- What is the difference between an asset and a liability?
- How could a business have higher sales revenue but a lower net profit margin?
