📄 What is a Profit and Loss Account?
Definition: A profit and loss account (also called an income statement) shows a business's revenue, costs and profit or loss over a specific period of time (usually one year).
It answers the most fundamental question: did the business make money or lose money?
- Covers a specific time period (e.g. year ending 31 December 2025)
- Shows how revenue is earned and where money is spent
- Required by law for all limited companies
- Used by managers, investors, banks and tax authorities
The IB syllabus uses both terms — 'profit and loss account' and 'income statement' mean the same thing! 📝
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🏗️ Structure of the Income Statement
The income statement follows a standard layout from top to bottom:
- Sales revenue — total income from selling goods/services
- Minus Cost of goods sold (COGS) — direct costs of products sold
- = Gross profit
- Minus Expenses (overheads) — rent, wages, marketing, depreciation etc.
- = Net profit (profit before interest and tax)
- Minus interest and tax
- = Profit for the year (net profit after tax)
Think of it as a funnel — you start with ALL the revenue at the top and subtract costs layer by layer until you reach the profit at the bottom 🔽
Revenue flows down through deductions to reach net profit
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🔢 Constructing a Simple Income Statement
Example: Bella's Boutique — Year ending 31 Dec 2025
Sales revenue: $120,000 Cost of goods sold: $48,000 Gross profit: $72,000
Expenses: Rent: $12,000 Wages: $30,000 Marketing: $5,000 Utilities: $3,000 Depreciation: $2,000 Total expenses: $52,000
Net profit: $72,000 − $52,000 = $20,000
- Always start with sales revenue at the top
- Subtract COGS to get gross profit
- List all expenses and subtract the total from gross profit
- The final figure is net profit (or net loss if negative)
In the exam, lay out your answer neatly with clear labels and show EVERY step of the calculation — presentation matters! ✨
📦 Cost of Goods Sold (COGS)
Formula: COGS = Opening stock + Purchases − Closing stock
COGS represents the direct cost of the products that were actually sold during the period — not everything that was bought.
Example: Opening stock: $10,000 Purchases during the year: $50,000 Closing stock: $8,000
COGS = $10,000 + $50,000 − $8,000 = $52,000
Opening stock = what you started with. Add what you bought. Subtract what's left. What's gone = what you sold! 📊
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🔍 Interpreting the Income Statement
Numbers alone are not enough — you need to understand what they mean for the business.
- High gross profit but low net profit → expenses are too high (poor cost control)
- Low gross profit → COGS is too high or selling prices are too low
- Net loss → total costs exceed revenue — the business is losing money
- Compare with previous years → is profitability improving or declining?
- Compare with competitors → is the business performing above or below the industry?
In the exam, don't just state the numbers — EXPLAIN what they mean and SUGGEST what the business should do about it! This gets you into the higher mark bands 🎯