Businesses record transactions to answer one big question: did we make a profit? The income statement answers it, and a simple version is easier than it looks.
Every debit and credit a business records feeds into one of two reports. The income statement tells the story of one trading period. Once you can read its shape, the rest of IGCSE Accounting starts to fit together.
The basic shape
An income statement flows downwards:
- Revenue: the income from sales.
- Cost of sales: what those goods cost the business.
- Gross profit: revenue minus cost of sales.
- Expenses: the running costs (rent, wages, electricity).
- Profit for the year: gross profit minus expenses.
The order is deliberate. You start with money coming in, subtract the direct cost of the goods that earned it, and only then take away the wider running costs. Each line answers a different question, and keeping them in order stops you mixing up costs that behave differently.
Why “for the year”
The income statement covers a period of time, usually a full year, and not a single moment. Hold on to this idea early.
It separates the income statement from the statement of financial position, which is a snapshot on one date. When you say a business made a profit, you mean over a stretch of trading.
Say a shop opened in January and closed its books in December. Every sale and expense in those twelve months belongs on that one statement.
Nothing from the next January does. Setting the period clearly is what makes the profit figure meaningful.
Gross profit vs profit for the year
There are two profit figures, and they must not be confused.
- Gross profit is the profit from buying and selling, before running costs.
- Profit for the year is what remains after every expense.
The gap between them shows how much running costs eat into trading profit. A business can have a healthy gross profit and still make very little at the bottom if its rent, wages and other expenses are high. That is why examiners ask for both.
Gross profit tests whether goods are bought and sold at a sensible margin. Profit for the year tests whether the whole business is worth running.
A worked example
A small shop has revenue of RM50,000. The goods it sold cost RM30,000, so gross profit is RM20,000.
Its expenses (rent, wages, electricity) total RM12,000. Profit for the year is RM20,000 − RM12,000 = RM8,000.
See what each subtraction tells you. The RM30,000 cost of sales leaves a RM20,000 gross profit, so for every RM1 of sales the shop keeps 40 sen after paying for its stock.
Then RM12,000 of running costs leaves RM8,000, so the shop keeps 16 sen of every RM1 of sales once everything is paid. Both percentages come from the same statement, so one tidy income statement can answer several exam questions.
A common confusion: cost of sales is not “everything the business spent”
Beginners often lump every payment together and call it “costs”. The income statement splits them on purpose. Cost of sales is only what the sold goods themselves cost. Expenses are the separate running costs of keeping the business open. Rent is an expense, not part of cost of sales, even though money goes out.
If you put rent into cost of sales, your gross profit will be wrong and every figure below it will drift too. Keeping the two groups apart is one of the most useful habits a Year 9 student can build.
Cost of sales with opening and closing inventory
The RM30,000 above was a simplified figure. In a fuller example, cost of sales is opening inventory plus purchases minus closing inventory. Suppose a business starts the year with RM4,000 of stock, buys RM32,000 more during the year and has RM6,000 of stock left unsold at the end.
Cost of sales is RM4,000 + RM32,000 − RM6,000 = RM30,000. Closing inventory is subtracted because those goods have not been sold yet, so their cost should not reduce this year’s profit. This follows the matching concept: the costs recorded in a period should be the costs of the goods actually sold in that period.
What profit does
Profit belongs to the owner, so it increases capital in the statement of financial position. If the owner takes some out, that is drawings, which reduce capital. Drawings are never an expense in the income statement.
This trips up many learners. Money the owner takes for personal use feels like a cost, but it is a withdrawal of the owner’s own profit, not a cost of running the business.
Putting drawings into expenses would understate the true profit and misstate capital. So send drawings straight to the capital section.
Why it matters
The income statement is not just an exam exercise. It is the first tool a real owner uses to decide whether a business is working.
It also connects to the next ideas you will meet. The figures that fill it come from a trial balance. And understanding cash vs credit transactions explains why revenue is not always the same as cash received.
Try it yourself
Exercise: A business has revenue of RM40,000, cost of sales of RM26,000 and expenses of RM9,000. Find the gross profit and the profit for the year.
Show the answer
- Gross profit = RM40,000 − RM26,000 = RM14,000.
- Profit for the year = RM14,000 − RM9,000 = RM5,000.
Ready for a real-world complication? Learn how buying and selling on credit works in cash vs credit transactions.
If any step still feels shaky, one of our teachers can build an income statement with you line by line, using your own school examples. Book a trial class.