Analysing Financial Performance
Why Businesses Publish Financial Statements
Every limited company in the UK has to publish financial statements each year. Investors read them before buying shares. Banks read them before lending. Managers read them to decide next year’s strategy. Employees read them to judge whether their jobs are safe. The two core documents are the income statement and the statement of financial position.
The Income Statement
The income statement (sometimes called the profit and loss account) covers a period of time — usually a full trading year. It starts with revenue at the top and works down through costs to arrive at profit at the bottom.
Revenue — the total money taken from sales over the period.
Cost of sales — the direct cost of producing what was sold (materials, direct labour, stock used).
Gross profit — revenue minus cost of sales. It shows how much money is made on the products themselves, before running costs.
Other operating costs — rent, marketing, office salaries, utilities. The overheads of running the business.
Net profit (profit for the year) — gross profit minus all other costs (including any finance costs and tax). The bottom line.
The Statement of Financial Position
The statement of financial position (balance sheet) is different. It is a snapshot in time — what the business owns and owes on one specific date, usually the last day of the trading year. The income statement is a film of the year; the statement of financial position is a photo at year-end.
Its two key categories are assets and liabilities. Assets are things the business owns — premises, vehicles, stock, cash in the bank, invoices owed by customers. Liabilities are what the business owes — bank loans, mortgages, unpaid invoices from suppliers.
Income statement = performance over a period (usually a year). Statement of financial position = a snapshot of what the business owns and owes at one point in time. One is a film, the other is a photo.
Profit Margins: Measuring Efficiency
Raw profit figures are hard to compare between businesses. A corner shop making £20,000 profit on £100,000 of sales is doing a great job. Tesco making £20,000 profit would be a disaster. That’s why managers convert profit into profit margin — a percentage that strips out the size of the business.
There are two core margin calculations in the AQA spec. Gross profit margin:
$$\text{Gross profit margin} = \frac{\text{Gross profit}}{\text{Revenue}} \times 100$$
Net profit margin:
$$\text{Net profit margin} = \frac{\text{Net profit}}{\text{Revenue}} \times 100$$
Worked Example — A Fashion Retailer
A UK fashion retailer reports revenue of £500,000, cost of sales of £300,000, and other operating costs of £150,000.
Step 1 — gross profit:
$$\text{Gross profit} = \pounds500{,}000 - \pounds300{,}000 = \pounds200{,}000$$
Step 2 — net profit:
$$\text{Net profit} = \pounds200{,}000 - \pounds150{,}000 = \pounds50{,}000$$
Step 3 — margins:
$$\text{Gross profit margin} = \frac{\pounds200{,}000}{\pounds500{,}000} \times 100 = 40\%$$
$$\text{Net profit margin} = \frac{\pounds50{,}000}{\pounds500{,}000} \times 100 = 10\%$$
The 30-percentage-point gap between gross (40%) and net (10%) margin tells a story: the business is making decent money on its products, but overheads are eating most of it. A manager looking at these figures would probe rent, marketing spend and head-office salaries.
Gross profit margin = (Gross profit ÷ Revenue) × 100. Net profit margin = (Net profit ÷ Revenue) × 100. A large gap between them shows high overheads eating into the profit made on the products themselves.
Making Judgements
Just calculating a margin isn’t enough — the figure only has meaning in context. Managers compare performance against:
Previous years — is gross profit margin rising or falling? A falling margin suggests rising supplier costs or price cuts that haven’t been passed on. A rising one suggests better buying power or a premium brand position.
Competitors — how does the margin compare to rivals in the same sector? Supermarkets typically run net margins of 2-5%: tiny mark-ups on huge volumes. Luxury brands charge far bigger mark-ups, so their gross margins are much higher — but a high gross margin does not guarantee a high net margin. In the year to March 2026 Burberry made £20 million of net profit on £2,420 million of sales, a net margin under 1%. Context decides whether a number is good or bad.
Different stakeholders read financial statements differently. Shareholders want rising margins. Employees want stable profits that secure jobs. Suppliers want healthy cash reserves that mean the business will pay its bills. No single figure answers every question.
Shareholders look at net profit margin and total profit — rising figures mean bigger dividends or a share price rise. Falling figures prompt awkward questions at the annual general meeting.
Managers look at the gap between gross and net profit margin to spot whether overheads are rising faster than product costs. They use the statement to decide where to cut costs or raise prices.
Employees and trade unions look at overall profitability — a loss-making year signals redundancy risk; a strongly profitable year is ammunition in pay negotiations.
Suppliers check the statement of financial position for assets and cash reserves — they want reassurance that invoices will be paid on time before extending trade credit to the business.