The Purpose of Accounting Profit and Loss

The core aim of any business is to survive The core aim of any business is to survive. After this, if it is in the private sector it will want to make a profit. If it is in the public sector it may want to improve or expand the services it provides. Either way, it will need to control its finances. By collecting all the available financial information and recording it in various accounts a business can assess how well it is performing. This is important both for a business internally as well as externally.

Internally Managers want to know how much they are selling, the level of their costs and the amount of profit they are making. From this information they can set budgets and performance targets to plan for the next trading year. An accountant can show managers where financial problems might be occurring within their company.

Externally All businesses are legally required to keep records of their finances. A firm has to make its accounts available to the Inland Revenue (Corporation Tax), and Customs and Excise (VAT). The larger the business, the stricter the rules on what accounts it has to prepare.

Most business have to prepare a: Trading and Profit and loss account Balance sheet Directors' report (describing the previous year's activities) Limited companies also have to publish an annual report and final accounts because they have a separate legal identity.

Trading accounts and profit and loss accounts At the end of every trading year a business prepares final accounts. These provide a financial summary of all their trading activity during the year.

The trading account shows the gross profit (or loss) that the company has made. Profit is the money made by the business and equals income minus expenses.

The profit and loss account shows the net profit (or loss) made The profit and loss account shows the net profit (or loss) made. The Trading account and profit and loss account are often combined as one trading and profit and loss account so that both the gross and net profit can be displayed in the same set of accounts.

Profit and Loss : An example The opening stock and purchases are added together and then the closing stock is subtracted to give the cost of sales total. This amount is then subtracted from the turnover to give a gross profit figure.

Profit and Loss : An example The Account then continues: It shows the rest of the annual expenditure which is the normal cost of running a business, plus Depreciation and bad debts. These are deducted from the gross profit to give the true profit: the net profit.

Turnover Marked up price Cost of sales Opening stock Purchases Closing stock Depreciation Bad Debts Gross Profit Net Profit Assets

Turnover This is the total revenue or income from sales. In other words this is all the money a business receives from selling goods or services.

Net Profit This is the gross profit minus expenses. For example: wages, rent, rates and advertising.

This is everything a firm owns. Assets This is everything a firm owns.

Marked up price This is the price after the company has added its own profit margin on top of the price it cost to produce the goods.

This shows how much they have spent on Cost of sales This shows how much they have spent on buying the goods at cost price before the firm has added its own profit margin.

Opening stock This is the value of stock remaining unsold from the previous year.

Purchases Purchases are the amount spent on new stock during the current year.

Closing stock Closing stock is the value of stock left unsold this year to be carried forward.

This is the loss of value through wear and tear. Depreciation This is the loss of value through wear and tear.

Bad Debts This is the amount owed to a firm by a customer that will not be recovered (they will not get this money back).

This is the profit before the expenses are taken out. Gross Profit This is the profit before the expenses are taken out.