Managing Finance and Budgets Lecture 5 Profit & Loss Accounts

Profit & Loss Equation for a period Profit (loss) Total expenses incurred in generating the revenue less equals Total revenue

The Format of the P & L Account Normally a Profit & Loss Account will consist of: Sales (Turnover) Less Cost of Sales = Gross Profit Less Overheads = Net profit Less Interest on Loans = Profit Before Tax Less Tax = Profit after Tax Less Dividends = Retained profit for the year P & L Terms: For a quick explanation Click Here

Terms on the Profit and Loss Account Turnover: Total value of sales over a given period - sometimes called Income or Revenue Cost of Sales: The costs incurred in making the sales in a given period Overheads:Other costs incurred in running the business, but not directly related to making sales Interest on Loans: Money paid to lenders for the privilege of borrowing money. Tax: Money paid to the government as a contribution to the National Exchequer. Dividends: Money paid to shareholders as a ‘reward’ for investing in the company.

Turnover (Sales) (Income)£ 100,000 Cost of Sales (Direct Costs) Materials£10,000 Transport£ 5,000 Labour£15,000 Total Cost of Sales £ 30,00030% Gross Profit (Gross Margin)£ 70,00070% Overheads (Indirect Costs) Administrative salaries£18,000 Depreciation£ 5,000 Rent & Rates£ 4,000 Total Overheads £ 27,00027% Operating Profit (Net Margin)£ 43,00043% Interest on loans£ 3,000 Profit before tax£ 40,00040% Corporation tax due £8,000 Profit after tax & interest£ 32,00032% Dividends payable£22,000 Retained Profit (Earned Surplus) £ 10,00010%

Some Issues  Cash versus Profit  Capital & Revenue Costs  Cost of Sales  Valuation of Stocks  Depreciation  Bad Debt Provision  Prepaid Expenses  Accrued Expenses

Cash Versus Profit  In accounting terms, to calculate Profit (or Loss) Sales Income must be matched against relevant expenditure for a given period  Some goods may be purchased on credit, some sales may be sold on credit  Some purchases may have a useful life which lasts longer than the given period  Therefore Profit in accounting terms is NOT equivalent to Cash in less cash out during that period

Capital & Revenue Costs  Capital Costs are incurred in purchasing assets  Revenue Costs are incurred in delivering the goods or services and operating the company  Capital Costs are not charged directly to the Profit & Loss Account. They are reflected in a depreciation charge over their useful life.  Accounting profit = Revenue Income less Revenue Expenditure - Capital expenditure is only deducted from Accounting profit through depreciation  To “capitalise” an item means to treat it as capital expenditure

Cost of Sales This is the cost of goods sold over a period. For retail and manufacturing companies this will mainly be the amount of stock throughput, and can be calculated by: Opening stock level for the Period + Amount of stock purchased during the period - Closing stock level for the Period = Cost of materials during the Period

Stock Valuation Methods Three methods First in, first out (FIFO) Last in, first out (LIFO) Weighted average cost (AVCO)

Depreciation  Depreciation is the method used to spread the cost of a purchase (normally of a fixed asset) over a number of time periods (usually years) This is a way of charging to the business the cost of the asset, in a way which accounts for the ‘wear and tear’ of the asset, and the fact that over time it is reducing in value. Depreciation is shown in the Profit & Loss Account as an Overhead

The Problem of Bad & Doubtful Debts  Many businesses sell goods on credit. The revenue generated is recognised in accounts as soon as the goods are passed to the customer.  As soon as this happens, the sale is recorded, and the amounts appear as Turnover on the P & L account, and as Trade Debtors on the Balance Sheet.  There is a risk that the customer will not, or cannot pay. If this occurs then this is called a bad debt and must be written off.  This involves reducing debtors on the Balance Sheet, and creating an expense in the ‘Overheads’ section for Bad Debt.

Accrued Expenses Accrued expenses - any amount which the organisation owes for expenses already consumed but for which a bill has not been yet received or paid When you eat in a ‘posh’ restaurant they normally provide you with the food, then present you with the bill at the end. At the point at which you have eaten the meal, but not paid, this is an accrued expense. Accrued expenses are things like tax, dividends, wages and fuel bills.