1. Nursery Management Understanding and Managing Finance Session 5

2. The Profit and Loss Account  In Session 2 we saw an example of a Profit and Loss account for a day’s trading in at a car boor stall.  Before we see an example of a ‘real’ Profit and Loss account, we need to understand:  the idea of revenue  the idea of expenses

3. Further Financial Terms  Income – An amount of money which comes in to, or is earned by, the business during an accounting period - sometimes called Revenue  Turnover - total value of sales over a given period – this is sometimes called Income or Revenue  Its likely that most of your income will be received by parents/guardians So what is actually meant by the term Revenue?  Revenue – technically this simply refers to the inflow of assets, or the reduction in claims that arise as a result of trading operations.

4. Financial Terms Expenditure – An amount of money which has been spent by, or goes out from, the business during an accounting period. Cost - the amount of actual or notional expenditure incurred on or attributable to a specified thing or activity (fixed, variable, direct, indirect )

5. The Format of the P and L Account Normally a Profit and 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

6. Terms on the Profit and Loss AccountProfit and Loss TurnoverTurnover: Total value of sales over a given period - sometimes called Income or Revenue Cost of SalesCost of Sales: The costs incurred in caring for the children in a given period OverheadsOverheads:Other costs incurred in running the business, but not directly related to caring for the children Interest on LoansInterest on Loans: Money paid to lenders for the privilege of borrowing money. TaxTax: Money paid to the government as a contribution to the National Exchequer. DividendsDividends: Money paid to shareholders(of a limited company) as a ‘reward’ for investing in the company.

7. Turnover  In early years settings this will usually be fees for services  Subscriptions  Interest earned ( for example if you have money on deposit at the Bank)  To all intents and purposes, Income = Revenue = Sales = Turnover  VAT is excluded from Sales figures (and all other figures)

8. Cost of Sales (Direct Costs)  Costs which are directly related to the cost of providing the goods or service (Cost of Sales)  For example:Goods purchased for resale(for example tee shirts advertising your crèche) Direct Labour costs Raw materials, Packaging, Energy  Direct Costs often vary with sales (though some Direct Costs can be FIXED)

9. Overheads (Indirect Costs)  Operating Expenses  Costs which are not directly related to child care.  Costs which are incurred even when an organisation produces no output. Often Fixed Costs  For example:Administrative salaries Advertising, Stationery, Rent and Rates Insurance, Bank charges Depreciation  Indirect Costs do not (necessarily) vary with ‘sales’  Interest usually shown later

10. Interest on Loans Includes  Interest on Bank loans and other formal loan arrangements (e.g. debentures). These are normally charged at some fixed rate e.g. 12% of the loan  Interest on Overdrafts (rates may be variable), and more expensive (e.g. up to 15%) Does not include  Money paid to shareholders in dividends  Interest charged by creditors for late payment

11. Tax  Corporation Tax is charged on profits made after all costs and interest charges (but not dividends) have been accounted for.  In the examples in the slides, a ‘flat rate’ of 20% is used, to simplify calculations  For more on tax in the UK consult: http://www.inlandrevenue.gov.uk/rates/corp.htm

12. Dividends  Limited companies are financed primarily through shareholding.  Shareholders buy shares in the company. These may have a face value ranging anywhere from 1 penny to thousands of pounds.  At the end of each financial period, the directors of the company may decide to issue dividends. This is money paid to the shareholders out of net profit after tax, as a reward for their continued investment.  The dividend paid does not affect the face value of the share.

13. Profit or (Loss) There are many different sorts of profit:  Gross Profit = Sales less Direct Costs  Operating Profit = Sales less Direct Costs less Indirect Costs  Profit before tax = Operating Profit less Interest  Profit after tax = Profit before tax less tax  Retained profit = Profit after tax less dividends

14. Activity 1 Which type of Profit specifically might you be interested in if you were:  A Shareholder  The Inland Revenue  The Nursery Manager  The Managing Director

15. Activity 1 solution Which type of Profit might you be interested in if you were: A Shareholder  All types of profit, but specifically profit after tax, and the amount that the company has offered in dividends and the retained profit. The Inland Revenue  Profit before Tax The Nursery Manager  Normally Turnover and Gross Profit The Managing Director  All types of profit, but specifically the Retained Profit, which will be reinvested into the company.

16. Sample Profit and Loss Account The next slide shows a profit and loss account for a company over a one-year period. The format varies according to the type of business, but there is a fairly uniform convention to structure the accounts in the following way: Total Income: Less expenditure item #1 Less expenditure item #2 Less expenditure item #3etc. = Earned Surplus (Profit)

17. 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 and 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 and interest£ 32,00032% Dividends payable£22,000 Retained Profit (Earned Surplus) £ 10,00010%

18. Depreciation Methods There are two main methods used:  Straight-line depreciation = Cost of item divided by number of years over which it is to be written off  Reducing balance = Current value x Depreciation%

19. Activity 2 Discuss the following:  Why does an increase in cash in the bank during a particular accounting period not necessarily mean that the organisation has made a profit?  Why is it important to distinguish between capital and revenue expenditure?  Why is it important to differentiate between indirect and direct costs?

20. Activity 2 – Possible Solution  Increase in cash in the bank could be the result of: a loan, payment of a previous debt, selling off an asset, even selling goods at a loss! None of these incurs profit.  Capital expenditure buys things still owned by the company. Revenue expenditure ‘disappears’.  Indirect costs need to be paid even if you don’t sell anything; in difficult times overheads need to be cut.