Key definitions
- Gross profit — the money left over after deducting costs from revenue.
- Operating profit — gross profit minus overheads (day-to-day expenses).
- Retained profit — the money left over after deducting expenses (including taxes) and dividends (the shareholders' share of profit) from operating profit.
An income statement shows how well a business is doing financially, and the value of the business's income and expenditure (spendings).
Key formulas
Profit = Revenue − Total cost of production
Operating profit = Gross profit − Overheads
Retained profit = Operating profit − Tax − Dividends
Importance of profit to private sector businesses
- It is a reward for risk taking / enterprise.
- It is a source of finance.
- It is a way to measure success.
Profit vs cash
- Cash — all the money that is available to a business physically and in the bank, not including deducted costs and debts.
- Cash may not be profit, as some cash may be used to pay trade payables, for example.
- Profit — the money available after deduction of these costs and expenses.
Worked example: income statement
Income statement figures
| Item | Amount |
|---|---|
| Gross profit | 60,000 |
| Overheads — Rent | 2,000 |
| Overheads — Salaries | 5,000 |
| Overheads — Water | 1,000 |
| Operating profit | 52,000 |
| Less: Corporate Tax (15%) | 7,800 |
| Net profit after tax | 44,200 |
| Dividends to shareholders (20%) | 8,840 |
| Retained profit | 35,360 |
How the figures work through
- Overheads total 8,000 (Rent 2,000 + Salaries 5,000 + Water 1,000), deducted from gross profit of 60,000 to give operating profit of 52,000.
- Corporate Tax at 15% of operating profit is 7,800, leaving a net profit after tax of 44,200.
- Distribution of profit: dividends to shareholders at 20% are 8,840, leaving a retained profit of 35,360.