Profit and Loss Accounts

A businesses key objective is to make a profit. All other aims (e. g A businesses key objective is to make a profit . All other aims (e.g. reputation, market share etc.) all rely on the firms financial success. Purpose of profit: Help in the allocation of resources. Profitable firms attract investors. Acts as a measure of business performance for investors, workers, suppliers and customers. It is a reward for risk. Used for new investments. Costs: To analyse performance, this division of cost is used to calculate two profit figures: Gross Profit: Sales Revenue – Direct Costs Net Profit: Sales Revenue – Direct & Indirect Costs If 1 is high and 2 is low this would indicate that direct costs are being efficiently managed and control of indirect costs needs improvement. BUT such judgments can only be made with full information about the business and by comparison with similar businesses.

Are profits under the firms control? Profit & Loss Accounts These include gross profit, operating profit, profit before tax, profit after tax etc. Each highlights a different area of performance, e.g. how much profits are paid-out in interest, how much costs are due to administrative expenses etc. Are profits under the firms control? YES: managers control marketing, operations, H.R., finance (etc.) decisions. All these affect profit. NO: Firms don’t operate in a vacuum. They can’t influence technological change, economic climate, suppliers, competition (etc.) to any great extent. BUT: Successful managers can anticipate change and react effectively to them (NB- opportunity as well as threat.) What factors affect profit quality? i.e. Are the firms profits a one-off or is it in a strong position for the future. Are the increased profits due to sale if fixed assets? Are the profits due to cutting back R&D expenditure? Are there underlying cash-flow problems e.g. credit sales? Therefore one must examine if the level of profit is sustainable. Trends must be examined, overall size, internal & external change etc.

Is profit a good measure of success? Profit Utilisation This refers to how profits are distributed (to owners or retained within the business). The decisions depends on: The firms future plans. The firms present competitive state. The desire of owners for immediate rewards. e.g. If it wishes to expand it will retain more profit. Owners may want higher dividends (this depends on what other firms give, is the value of the firm rising and are they LT or ST investors?) NB- In UK most powerful investors are institutions e.g. pension funds, and therefore want high ST payouts. Q: Why does this cause UK firms problems? Is profit a good measure of success? It is important, as it’s not worth doing something if the value of the output is lower than the value of the input, but it has its’ limitations. It ignores: A firm’s contribution to society A firm’s ethics Are stakeholders interests being met / satisfied? Employer-employee relations A firms LT profit