Using the Income Statement (AQA GCSE Business)

Revision Note

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Written by: Lisa Eades

Reviewed by: Steve Vorster

Profit Margins

Profit margins measure how successfully a business converts revenue into profit
Profitability can be measured in two ways:

The gross profit margin

The proportion of revenue that is converted into gross profit
It is calculated using the formula

$Gross profit margin = \frac{Gross profit}{Revenue} x 100$

Worked Example

Head to Toe Wellbeing’s revenue in 2022 was $124,653. Its gross profit was $105,731

Calculate Head to Toe Wellbeing Ltd’s gross profit margin in 2022. [2 marks]

Step 1: Substitute the values into the formula

$Gross profit = \frac{Gross profit}{Sales revenue} \times 100$

$= \frac{$ 105, 731}{$ 124, 653} = 0.8482$ [1]

Step 2: Multiply the outcome by 100 to find the percentage

$= 0.8482 \times 100 = 84.82 %$ [1 mark]

84.82% of Head to Toe Wellbeing’s revenue was converted into gross profit during 2022

The net profit margin

The proportion of revenue that is converted into net profit
It is calculated using the formula

$Net profit margin = \frac{Net profit}{Revenue} x 100$

Worked Example

Head to Toe Wellbeing’s revenue in 2022 was $124,653. Its net profit was $65,864

Calculate Head to Toe Wellbeing Ltd’s net profit margin in 2022. [2 marks]

Step 1: Substitute the values into the formula

$Net Profit Margin = \frac{Profit Before Interest and Tax}{Sales Revenue} \times 100$

$= \frac{$ 65, 864}{$ 124, 653} = 0.5284$ [1]

Step 2: Multiply the outcome by 100 to find the percentage

$= 0.5284 \times 100 = 52.84 %$ [1]

In 2022, 52.84% of Head to Toe Wellbeing’s revenue was converted into profit before interest and tax

Profit margins are expressed as percentages
- This allows comparison of business performance over time and also comparisons with other businesses

Stakeholders and profitability

Several stakeholders are interested in profitability
- Investors look carefully at profitability when deciding which business to invest in
  - The higher the level of profitability, the higher their rewards are likely to be
- Directors and managers consider profitability when assessing business success and determining future objectives and strategy
- Employees may consider profitability as justification for requesting higher wages or better working conditions

Using the Income Statement to Judge Performance

Income statements inform managers whether the business is making a profit or loss
- They allow managers to:
  - Compare performance to previous years
  - Make future forecasts
  - Make comparisons with competitors
Finance managers are able to interrogate the data in order to make decisions, make beneficial changes or set new strategic objectives

Case Study

Chillie's Cafe

Chillie's Cafe sells cold drinks during the summer season in central Berlin
Its two best-selling products are bubble tea and smoothies

Diagram: Extracts from Chillie's Cafe's Income Statement

The income statement contains a range of information that can be used to make decisions and judge performance

Although Chillie's sells bubble tea drinks at a higher price, smoothies are more profitable for the business
- Fewer bubble tea drinks than smoothies are sold, so revenue is lower
- The cost of sales of bubble tea are higher than those for smoothies

Questions to Consider when Analysing the Income Statement

If the Business is Making a Profit	If the Business is Making a Loss
Is the profit higher or lower than last year? If higher, what has the business done that could have led to this? E.g. 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 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 E.g. E-commerce growth has led to many high-street stores closing down as the number of customers has dwindled
Is the profit higher or lower than that of competitors? If lower, what can be done to become as profitable as other businesses? E.g. Does the business need to improve the quality of the products or increase the product portfolio?	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

Examiner Tips and Tricks

You will not be given the formulas in the exam, so you must ensure that you revise them thoroughly. You are usually asked to state the formula before applying it to a calculation.

Last updated: 19 April 2024

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Using the Income Statement (AQA GCSE Business)

Revision Note

Profit Margins

The gross profit margin

Worked Example

The net profit margin

Worked Example

Stakeholders and profitability

Using the Income Statement to Judge Performance

Case Study

Examiner Tips and Tricks

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Unlock more, it's free!

Join the 100,000+ Students that ❤️ Save My Exams

Author: Lisa Eades

Author: Steve Vorster