Financial Statements and Sources of Finance
Financial Statements and Sources of Finance
Financial statements show how a business is performing. Sources of finance are the ways a business can raise money to start, run or grow.
The Income Statement (Profit and Loss Account)
The income statement shows a business's revenue, costs and profit over a period (usually one year).
| Line | Formula |
|---|---|
| Revenue | Price x Quantity sold |
| Less: Cost of sales | Direct costs of producing goods sold |
| = Gross profit | Revenue - Cost of sales |
| Less: Operating expenses | Rent, wages, marketing, utilities, admin |
| = Operating profit (net profit) | Gross profit - Operating expenses |
Key Ratios from the Income Statement
| Ratio | Formula | What It Shows |
|---|---|---|
| Gross profit margin | (Gross profit / Revenue) x 100 | How much profit is made from each £1 of sales before overheads |
| Net profit margin | (Net profit / Revenue) x 100 | How much actual profit is kept from each £1 of sales after all costs |
| ARR (Average Rate of Return) | (Average annual profit / Cost of investment) x 100 | The percentage return on an investment per year |
- A high gross profit margin but low net profit margin suggests overheads are too high
- Comparing margins year-on-year or with competitors helps identify performance trends
The Statement of Financial Position (Balance Sheet)
The balance sheet shows what a business owns (assets), what it owes (liabilities) and the value to the owners (equity) at a specific point in time.
| Section | Includes |
|---|---|
| Non-current assets | Long-term assets: property, machinery, vehicles |
| Current assets | Short-term assets: stock, cash, debtors (money owed to the business) |
| Current liabilities | Short-term debts: creditors, overdraft, tax owed (due within one year) |
| Non-current liabilities | Long-term debts: bank loans, mortgages (due after one year) |
| Net assets | Total assets - Total liabilities |
| Equity | Capital invested by the owner(s) plus retained profit |
Sources of Finance
Businesses need finance to start up, cover day-to-day costs and invest in growth.
Short-Term Sources (up to 1 year)
| Source | Description | Advantages | Disadvantages |
|---|---|---|---|
| Overdraft | Spending more than is in the bank account (agreed limit) | Flexible, only pay interest on amount used | High interest rate; can be withdrawn by the bank |
| Trade credit | Suppliers allow 30-90 days to pay | Improves cash flow; no interest | May lose early-payment discounts; strains supplier relationship |
| Factoring | Selling unpaid invoices to a factoring company for immediate cash | Instant cash; reduces admin | Only receive 80-90% of invoice value |
Long-Term Sources (more than 1 year)
| Source | Description | Advantages | Disadvantages |
|---|---|---|---|
| Personal savings | Owner's own money invested | No interest payments; no loss of control | Limited amount; personal financial risk |
| Bank loan | Borrowing a fixed amount repaid with interest over a set period | Large amount available; fixed repayments aid planning | Interest costs; requires security; may be refused |
| Mortgage | Loan specifically for buying property | Large amount; long repayment period (25+ years) | Property is at risk if payments are missed |
| Share capital | Selling shares in the company to investors | Large amounts can be raised; no repayment required | Dilutes ownership and control; dividends expected |
| Venture capital | Investment from specialist firms in exchange for equity | Large amounts; expertise and advice | Loss of control; investor expects high returns |
| Retained profit | Reinvesting profit back into the business | Free (no interest); no loss of control | Only available if the business is already profitable |
| Crowdfunding | Raising small amounts from many people online (e.g. Kickstarter) | Market validation; no debt; builds a customer base | Time-consuming; no guarantee of success; may need to offer rewards |
| Government grants | Free money from government for specific purposes (e.g. green energy, start-ups) | Free — no repayment required | Competitive; specific criteria; may take time to receive |
Choosing the Right Source
The best source depends on:
- How much money is needed
- How quickly it is needed
- How long it is needed for
- The business's stage (start-up vs established)
- Whether the owner wants to keep full control
- The cost of the finance (interest, equity dilution)
Exam Tips
- Be able to calculate gross profit, net profit and profit margins from given data
- Know the difference between short-term and long-term sources of finance
- For evaluation: Which source is best? Always justify based on the specific business scenario
- Link financial statements to business performance — falling profit margins signal problems
- Remember: the balance sheet must balance — net assets = equity