Profit and Loss Unit 5: Financial Planning Photo: © wrangler, shutterstock.com

Why do businesses record their profit or loss? What is a financial year? What is a profit and loss account? What parts make up a profit and loss account? How are the figures calculated in a profit and loss account? Learning objectives

Profit and loss accounts Every business – however small or large – aims to make a profit. For a business to be able to calculate whether it has made a profit, it must keep a profit and loss account. A profit and loss account summarizes all of a business’s revenue and costs over a period of time, usually a year. The business then uses the figures in it to work out how much profit or loss it made. Teacher’s note: A profit and loss account is useful for a business as it enables it to analyse its performance, try to forecast its future profits to help it plan whether to change its activities and so the business’s shareholders can see how well the business is performing. Why is producing a profit and loss account useful for a business?

How could ICT help a business to prepare its profit and loss account? A business produces a profit and loss account because: it is a legal requirement it sums up the performance of a business to its stakeholders it can be compared with the previous year’s performance investors or lenders need to see one before making deals it can help to forecast future profits and helps with planning. Teacher’s note: A business could use the sales and expenses data from its databases, then the figures could then be entered into a spreadsheet which could calculate the totals quickly and accurately. Photo: © 2009 Jupiterimages Corporation How could ICT help a business to prepare its profit and loss account?

The financial year Businesses are legally required by the government to produce annual profit and loss accounts at the end of each financial year for the Inland Revenue. Do you know when the financial year begins and ends in the UK? The UK’s financial year runs from 6th April to 5th April. At the end of each financial year private limited (Ltd) and public limited (PLC) companies must produce audited annual accounts for the Inland Revenue – for it to calculate how much tax they owe.

Profit and loss account A profit and loss account can be presented in different ways, but many businesses divide it into three distinct sections: the trading account the profit and loss account the appropriation account. It can be recorded by hand into an accounts ledger, or entered into a computer spreadsheet or accounts package.

The trading account The first section of the profit and loss account is called the trading account. It shows the revenue the business earned from sales, the cost of production and changes in stock. The business uses this data to work out how much gross profit it has made.

The layout of a trading account Teacher’s note: The closing stock will become the opening stock in the following year’s trading account. What will the closing stock become in the following year’s trading account?

Calculating the trading account Can you remember the formulae needed to complete a trading account? £ £ Sales revenue 67 865 opening stock + purchases – closing stock = cost of sales Opening stock 24 514 Purchases 47 865 Closing stock 34 217 sales revenue – cost of sales = gross profit Cost of sales 38 162 Gross profit 29 703

Completing a trading account Teacher’s note: The cost of sales is purchases (£52,145) + opening stock (£24,156) – closing stock (£31,216) = £45,085. The gross profit is sales revenue (£107,000) – cost of sales (£45,085) = £61 915.

The profit and loss account The second section is called the profit and loss account as it is where the net profit before tax (or loss) is calculated. The profit and loss account records the business’s expenses or overheads so that the operating profit can be calculated.

The layout of a profit and loss account

Calculating a profit and loss account Can you remember the formulae needed to complete a trading account? Total expenses = the sum of all the expenses £ £ Gross profit 29 703 Expenses Gross profit – total expenses = operating profit Salaries/wages 8 246 Rent 3 456 Utilities 1 897 Equipment 965 Operating profit – interest on loans = net profit before tax Other 587 Total expenses 15 151 Operating Profit 14 552 Interest on loans 1 216 Net profit before tax 13 336

Completing a profit and loss account Teacher’s note: The total expenses is the sum of the expenses (£20,145 + £7,891) = £28,036. The operating profit is the gross profit (£61,915) – total expenses (£28,036) = £33,879. The net profit before tax is the operating profit (£33,879) – interest on loans (£5,432) = £28,447. The operating profit is a useful figure for a business to know because it shows the profit from its business activity. Then it can make a judgement about what areas to expand or decrease without the figure being clouded by the interest on loans payment. Why is it useful for a business to work out its operating profit?

The appropriation account The third section of the profit and loss account is the appropriation account. It shows exactly what has happened to the net profit before tax the business made. It shows the tax the business had to pay (corporation tax if it is a company or income tax if not). Then it shows the dividends it paid to its shareholders and any retained profit it kept for reinvestment.

The layout of an appropriation account Teacher’s note: Students should be asked to write a one sentence definition of all the terms highlighted on this sheet. Write a sentence to describe each term in your own words.

Calculating an appropriation account Can you remember the formulae needed to complete an appropriation account? £ £ Net profit before tax – corporation tax = profit after tax Net profit before tax 13 336 Corporation tax 2 667 Profit after tax 10 669 Profit after tax – dividends = retained profit Dividends 4 897 Retained profit 5 772

Completing an appropriation account Teacher’s note: The profit after tax is net profit before tax (£28,447) – corporation tax = £22,749. The retained profit is profit after tax (£22,749) – dividends (£9,786) = £12,963.

Who uses a profit and loss account?

Using ICT Teacher’s note: This drag and drop interactive is printable either as a solved answer sheet (when the print button is pressed after the activity has been solved) or as an unsolved worksheet at any other time.

Profit and loss account activity Complete this profit and loss account by entering the missing values into the coloured cells. Spreadsheet: This slide is accompanied by spreadsheet Profit and Loss slide 21. Teacher’s note: To turn the profit and loss account into an Excel spreadsheet, double click on it in ‘normal view’. The answers can be found be clicking on the ‘Sheet2’ tab. The Excel file for this spreadsheet is provided in the Spreadsheets folder on the product CD.

Question time What is another name for a business’s sales revenue? Does the money spent on materials affect the gross profit figure only, the net profit figure only or both profit figures? What is the formula for profit after tax? Which type of profit shows how successful the business activity has been? Suggested answers: A business’s sales revenue can also be called its sales turnover, turnover or revenue. Money spent on materials affects both gross profit and net profit. The formula for profit after tax is: net profit before tax – corporation tax. Operating profit shows how successful the business activity has been.

Who wants to be an A* student? Answers: Revenue and costs Loss Stakeholders Forecast The Inland Revenue 5 April – 6 April Become investors Companies Competitors Data sharing is easier

Glossary Teacher’s note: To test students’ understanding of the topic, you may wish to ask them what each word in the glossary means before pressing to reveal the definition. Alternatively, you may wish to set students an extension or homework activity to research and define the terms. The definitions provided here can be used as an additional point of reference once they have completed the task.