The purpose and content of the main financial statements (the income statement and the statement of financial position), the figures they show, and the users of financial information.

What this key area is asking

Firms must measure their profit and financial position, and the SQA wants you to know the purpose and content of the two main financial statements, the income statement (profit and loss) and the statement of financial position (balance sheet), the key figures they contain (such as gross and net profit), and the users of financial information. Higher rewards you for distinguishing the statements and explaining who uses them and why.

The income statement

The income statement works down in stages:

• Sales revenue: the total value of sales in the period.
• minus Cost of goods sold (the cost of buying or making the items sold) = Gross profit (the profit from buying and selling, before running expenses).
• minus Expenses (wages, rent, insurance, advertising, etc.) = Net profit (profit for the year) (the actual profit after all costs).

The statement of financial position

It contains:

• Non-current (fixed) assets: items kept long-term, such as premises, vehicles and machinery.
• Current assets: items that change quickly, such as stock (inventory), debtors (money owed by customers) and cash.
• Liabilities: what the firm owes, such as loans (non-current) and creditors and overdrafts (current).
• Capital/equity: the owners' investment plus retained profit.

It shows the firm's value and financial strength, and whether it can pay its debts.

The users of financial information

Many stakeholders use financial statements, each for a different reason:

• Owners/shareholders: the profit, return and value of their investment, and whether to invest more or sell.
• Managers: to control the business, make decisions and compare performance with targets.
• Lenders/banks: whether the firm can repay a loan, looking at profit, debt and liquidity.
• Suppliers: whether the firm can pay for goods supplied on credit.
• Employees/unions: job security and the firm's ability to pay wages and meet pay claims.
• Government/HMRC: to assess tax due and check the firm obeys the law.

Examples in context

Example 1. A shop with high gross but low net profit. A clothing shop has a strong gross profit because it buys clothes cheaply and sells them at a good mark-up, but its net profit is small because high rent, wages and advertising eat up most of the gross profit. The income statement reveals that the problem is expenses, not the buying and selling, so the owner targets costs. This shows why both profit figures matter and how the statement guides decisions.

Example 2. Different users, different interests. For the same set of accounts, shareholders focus on the net profit and return, a bank focuses on profitability and debt before lending, employees focus on job security and ability to pay wages, and HMRC focuses on the profit for tax. One financial statement serves many users, each reading it for a different purpose, the classic SQA point about the users of financial information.

Try this

Q1. State what the statement of financial position (balance sheet) shows. [2 marks]

• Cue. It shows what a business owns and owes at a single point in time: its assets (non-current and current), its liabilities (what it owes) and the capital/equity belonging to the owners, giving a snapshot of its value and financial strength.

Q2. Explain why two different users would be interested in a firm's financial statements. [4 marks]

• Cue. A bank/lender wants to judge whether the firm can repay a loan (profit, debt, liquidity); a supplier wants to know it can pay for goods on credit; shareholders want their return and value; employees want job security; HMRC wants the tax due. Pick two and explain each.