02 constructing financial statements

© Business Studies Online: Slide 1

The Trading Profit and Loss Account The Trading Profit and Loss Account

Businesses usually calculate their profit level by creating a Trading Profit and Loss Account (TPL)

The TPL is produced because: It is a legal requirement It summarises all the year’s transactions It shows the financial ‘health’ of the business. Can be used to compare trade this year with trade last year


The Parts of A T,P&L Account The Parts of A T,P&L Account

The document is made up of 3 sections which must be completed in turn:

The Trading Account

This calculates gross profit. It takes the

direct costs of production away from

the sales revenue

The Trading Account

This calculates gross profit. It takes the

direct costs of production away from

the sales revenue

The Profit & Loss Account

This takes the expenses (indirect

costs) away from the gross profit to

calculate net profit

The Profit & Loss Account

This takes the expenses (indirect

costs) away from the gross profit to

calculate net profit

The Appropriation Account

This shows what will happen to any profit

that has been made. It usually refers to

dividends and taxation

The Appropriation Account

This shows what will happen to any profit

that has been made. It usually refers to

dividends and taxation


The Structure of a TP&L Account (1) The Structure of a TP&L Account (1)

Trading Profit and Loss Statement For Lou Pole, year ending 31.08.04

£ £ Sales 400,000 LESS Cost of sales

Opening Stock 100 Purchases 100,000

100,100 Less Closing Stock 100

Gross profit 300,000

Sales, the money from selling goods

Business Name and

Date

Calculated by subtracting cost of sales from sales

Value of stock owned at the

start of the year

Value of raw materials purchased

during the year

Value of stock left at the end

of the year. This will be next year‛s OPENING

STOCK

100,000

Need to calculate how much it has cost to make the goods that have

been sold


£ £ Gross profit 300,000 LESS Expenses Salaries 75,000 Rent 25,000 Other 14,000 Total expenses Net profit 186,000

Corporation Tax 74,400 Profit after tax 111,600 Dividends 5,580 Retained profit 106,020

Expenses listed and

a total given Calculated by

subtracting expenses from Gross Profit

114,000 Calculated

by subtracting tax from net profit

Calculated by subtracting dividends. This is the amount of money that will be

kept in the business

The Structure of a TP&L Account (2) The Structure of a TP&L Account (2)


Different Types of T,P & L Accounts Different Types of T,P & L Accounts

The T,P & L Accounts of businesses will differ according to their legal structure Companies (Ltds & Plcs) are subject to more legal constraints:

The Accounts Of Incorporated Businesses

Accounts must be published Accounts usually show figures for 2 years They must show how the profit is being used (Appropriation Account)


The Limitations Of T,P & L The Limitations Of T,P & L

The trading, profit & loss account is a historical view of the business

It does not tell us what will happen in the future – although it may help to identify trends

Businesses may “manipulate” accounts in order to reduce their tax liabilities, or to deter a potential takeover


Working Capital Working Capital Working capital refers to the materials that a business needs in order to make the products that it sells

Without working capital a business would be unable to operate

It is the working capital that produces profit and as such it is referred to as an investment

However, working capital items are NOT intended to be kept by the business


How Money Works In Business How Money Works In Business Money constantly goes round a business in a cycle This can be shown as follows:


The Speed of the Working Capital Cycle The Speed of the Working Capital Cycle If the amount of cash at the end of the cycle is bigger than that at the start then a firm will make a profit How much profit depends upon how quickly they can get round this cycle. How quickly it can get round depends on two factors:

Speed of The Working Capital Cycle

Creditors

• People a business owes money to. • They speed up the cycle

Debtors

• People who owe the business money. • They slow down the cycle.


The working capital of a firm is calculated as follows:

Working Capital = Current Assets – Current Liabilities

Where: Current Assets =

Anything a business owns, which it intends to sell Examples include raw materials, stock, debtors and cash.

Current Liabilities = Anything that a business owes, which must be paid within the next 12 months Examples include creditors, overdraft and dividends.

This calculation is part of the BALANCE SHEET

Calculating the Working Capital Calculating the Working Capital


What is a Balance Sheet? What is a Balance Sheet?

A Balance Sheet is a financial statement which shows the ASSETS, LIABILITIES and CAPITAL of a

business on a particular date

Assets Are items owned

by the business or owed to the

business

Assets Are items owned

by the business or owed to the

business

Liabilities Are amounts owed

by the business

Liabilities Are amounts owed

by the business

Capital Is the money

invested by the owners or

shareholders

Capital Is the money

invested by the owners or

shareholders


The Key Principle of a Balance Sheet The Key Principle of a Balance Sheet

must equal All Assets All Liabilities

Businesses can only spend money that they either have, or have borrowed then:


The Structure of a Balance Sheet (1) The Structure of a Balance Sheet (1)

Balance Sheet For A.B.Hive LTD as at 31 December 2004

Fixed assets £ £ Building 170,000 Equipment 60,000

230,000

Current assets

Stock 30,000 Debtors 10,000 Cash at bank 5,000

45,000

Business Name and

Date

Fixed Assets are listed and then added up.

Current Assets are listed and

totalled



£ £ Current liabilities Trade creditors 25,000

Net Current Assets OR Working Capital Less Long Term Liabilities Mortgage 45,000 Loan 5,000

Net Assets 200,000

Current Liabilities listed and totalled Calculated by

current assets – current liabilities

Long Term liabilities are listed

and totalled,

then taken away

Calculated by fixed assets + working

capital – long term liabilities

20,000

50,000



FINANCED BY: £

Capital and reserves Share capital 75,000 Profit and loss account 125,000

Total Capital Employed 200,000

This section shows where the money in the

business has come from.

This means that £200,000 has been

invested in the business


Both the balance sheet and the profit and loss account show the ‘health’ of the business

All the stakeholders will be interested in the balance sheet, but especially:

Shareholders Customers Suppliers Employees

When used with the Trading Profit and Loss account it shows how well the business is doing

Who Uses A Balance Sheet? Who Uses A Balance Sheet?


The Limitations Of The Balance Sheet The Limitations Of The Balance Sheet

As soon as it is produced it is out of date Fixed assets may be overvalued if they are depreciated incorrectly Businesses are not required to include “intangible assets” such as brand names. This can understate the value of the company Companies tend not to give a breakdown of the figures – they just quote totals


Differences In Accounts Differences In Accounts Different types of business produce different types of accounts, due to legal requirements: Unincorporated Businesses

Must produce accounts for taxation purposes

Are usually in a simple format

T, P & L A/C will not have an Appropriation Account

Incorporated Businesses

Must publish accounts

Often abbreviated so competitors get limited information

Usually show 2 years figures

Some terminology is changed


There is a big difference between share capital and loan capital:

Share Capital Vs Loan Capital Share Capital Vs Loan Capital

Share Capital Loan Capital The total amount invested in a business by shareholders Note that share capital is NOT the same as Shareholders funds

Is medium – longterm finance provided by:

Banks Debentures Other lenders


Share Capital Vs Shareholders Funds Share Capital Vs Shareholders Funds Any profits invested in a business belong to it’s shareholders As such Shareholders funds can be calculated as:

Shareholders Funds = Share Capital + Reserves

02 constructing financial statements

Business

profit loss account

appropriation account

trading account

tpl account

trading profit

business businessis

sales revenuethe profit

money works