Transcript Profit & Loss Balance Sheet

Income Statements
Company Accounts
Lesson Objectives

By the end of this lesson, learners will
have knowledge and understanding of:
 An Income Statement
 Its uses and limitations
 How to construct a simple Income
Statement.
 Different headings – what do they
mean?
 The key terms used in a Income
Statement and their meaning
Income Statement

A record of a business’s trading activities
over a period of time.
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Usually one year.
Basically, shows:
How much the firm has earned from selling
its products or services [Revenue]
 How much it has paid out in costs [Costs]
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The net of the above = PROFIT!
Interested Parties

The Income Statement constitutes two vital pieces of
information to those interested in a business.
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Shareholders are an obvious example of stakeholder
assessing profitability.
Government agencies such as the Inland Revenue require
data on profit or losses to be able to calculate tax liabilities of
a company.
Suppliers to a business also need to know the financial
position of companies they trade with.

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Reliability, Stability and Creditworthiness.
Potential shareholders and bankers will also want to assess
the financial position of company before committing their
funds.
Uses of Income Statement

Can be a measure of success of a business
compared to other years.
 The calculation of profit can assess the actual
performance of a business against
expectations.
 It can help obtain loans or finance from banks
or other leading institutions.
 Can help the owners and managers of a
business to plan ahead, i.e. future investment.
Profit – to be or not to be!

Making a profit is the ultimate objective of any
business.
 However, other business have other motives.
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Charities – Redistribute resources
Co-op, building societies and many social clubs –
excellent customer services.
All businesses must ensure to generate enough to
at least match costs.
Income Statement

1.
2.
3.
The Income Statement itself is actually
divided up into sections:
The Trading Account - Calculates the gross
profit made on trading activities.
The Profit & Loss Account – Calculates the
overall level of profit made by a business.
The Appropriation Account – Concerned
with showing how any profits made by the
business have been distributed.
Layout for an Income Statement
Turnover/Sales
Trading
Profit and Loss
Account
Appropriation
Account
Less
=
Less
=
Plus
Less
=
Less
=
Less
=
Cost of Sales
Gross Profit
Expenses
Operating Profit
Non-Operating Income
Interest Payable
Profit on ordinary activities
Corporation Tax
Profit after Tax
Dividends
Retained Profit
Activity

Think of examples of as many items as
you can that will appear in each of the
three sections of an Income Statement
Trading Account
 Profit and Loss Account
 Appropriation Account

Measuring Profits
Profit = (Revenue) minus (Costs)
 However, to be more meaningful, profit
should be broken down into:


Gross Profit

Net Profit
Turnover/Sales Revenue

Turnover/Sales
Revenue

Shows the income from
selling goods and
services.

Goods manufactured but
not sold to customer are
excluded.

Goods which have been
sold to the customer, but
payment not received is
included.
Cost of Sales

Cost of Sales

Refers to all costs of
production.

Includes direct costs
such as:



Raw Materials
Wages of labour
Other indirect costs
associated with
production.
 Fuel and Rent
Example – Cost of Sale

Stock at 1st April 2001
 Add: Purchases during the year
£4,000
£14,380
£18,380
Less: Stock at 31st March 2002
 Cost of Sales
£4,500
£13,888

Your turn (on your own)
Have a go at this example.
 A business starts the year with £3400
stock
 It ends the year with £2800 stock
 It purchases £23100 during the year.
 What is the cost of sales?
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Example – Cost of Sale

Opening Stock
 Add: Purchases during the year
£3,400
£23,100
£26,500

£2,800
£23,700
Less: Closing Stock
 Cost of Sales
Gross Profit

Gross Profit

A measure of the difference
between turnover and the
cost of manufacturing and
purchasing the products
which have been sold.

Gross Profit does not include
expenses or overheads.

If a company is making a
lower level of gross profit
then are they paying too
much for supplies?
Overheads/Expenses

Overheads/Expenses

Those overheads or
indirect costs that are
not involved in the
production of goods and
services.

Subtracting expenses
from gross profit gives a
figure for OPERATING
PROFIT/NET PROFIT.
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Salaries & Wages
Rent, Rates &
Insurance.
Depreciation
Heating & Lighting
Repairs
Delivery Costs
Salesmen’s Salaries
Advertising
Rent, Rates & Insurance
of Sales office.
Interest of Loans
Heating & Lighting
Net Profit

Net Profit
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Often termed operating
profit.

Gross Profit – (expenses +
overheads) = Net Profit

A large gross profit does
not mean a large net
profit.

Operating profit is often regarded
as a key indicator of trading
performance.
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Profit made by a business from
its ordinary trading activities.
Costs may not be
managed and controlled
effectively = low net
profit.
Types of Ratio

Gross Profit Margin  This ratio examines the
relationship between
the profit made before
allowing for overhead
costs in relation to
 Basically, this ratio
turnover.
shows how well the
organisation is
managing its
purchases of stock.
Net Profit Margin Ratio

Net Profit Margin

Shows how well the
business manages
its other expenses.

This calculation
takes the idea of
profitability one step
further.
 The relationship
between the net
profit and the level of
turnover/sales made
after all other
expenditure has
been taken out is
measured.
Calculating Profit - Activity
Use the data and template provided to
draw up a profit & loss account
 15 minutes (ish!)
 If you finish – calculate the gross and net
profit margin
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Income Statement
Consolidated Profit & Loss Account for the year ended
Weeks
2003
2002
2001
52
52
52
Currency
£ million
£ million
£ million
Turnover
7688.0
8340.0
9278.0
Cost of sales
-7263.0
-8291.0
-8757.0
Gross Profit
425.0
49.0
521.0
Operating Expenses
-130.0
-137.0
-77.0
Operating Profit
295.0
-88.0
444.0
95.0
166.0
-68.0
Profit before interest and taxation
390.0
78.0
376.0
Net interest receivable (payable)
-255.0
-278.0
-226.0
Profit on ordinary activities before taxation
135.0
-200.0
150.0
Tax on profit on ordinary activities
-50.0
-71.0
-69.0
Profit on ordinary activities after taxation
85.0
-129.0
81.0
Equity minority interests
-13.0
-13.0
-14.0
Profit for the financial period
72.0
-142.0
67.0
Other costs/income
Dividends
Retained profit
0.0
72.0
-193.0
-142.0
-126.0
Dividend
–
Final
section
Profit
Turnover
Operating
Cost
Subtract
of
and
Sales
other
Loss
–or
Gross
Operating
Subtract
Profit
Subtract
tax
called
the
share
of=
Account
the
Net
–
costs
the
revenue
Profit
and
variable
for
=
Expenses
interest
turnover
––
due
to
get
‘appropriation
the
profit
British
earned
Gross
costs,
expenses
how
Airways
over
–
cost
the
payments/recei
fixed
ofprofit
sales
account’
–costs
shows
profit
on
returned
to
plc
the
operating
much
incurred
year
it
cost
to
costs
get
where
the
pts
to
get
ordinary
shareholders
the
profit
firm
before
profit/loss
is going
profit
onto
activities
produce
tax
what
ordinary
Retained
after tax
it
has sold
–
activities
Profit
– the
not
to be
before
tax
amount
kept
confused
with
back for future
sales
revenue!
investment,
etc.
Source: http://www.bized.ac.uk/cgibin/ratios/ratiodata.pl
Profit Quality

Profit quality measures whether or not
individual profit sources will continue.
Make one off profits from the sale of Assets
= Low Profit Quality
 A company with strong trading position,
which is expected in future years = High
Profit Quality.
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Limitations of Income Statement
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Profit and Loss cannot be used to show what
is going to happen in the future.
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Historical information used.
However, can be used to identify possible future
trends by looking at the profit or loss over a longer
period of time.
Investors/stakeholders must appreciate that
the figures could be disguised or manipulated.
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Hide its profit to reduce tax or to deter a potential
takeover.
A business may try to show a greater profit to
satisfy shareholders.
Interpretation

A gross profit percentage of 5% means the
firm makes a £5 gross profit on every £100 of
goods sold.
 A gross profit percentage of 85% means the
firms makes £85 gross profit on every £100 of
goods sold.

There is no ideal level for this percentage – it
depends on the type of business.
Interpretation

The higher the profit margin a business makes
the better.
 Gross profit margins vary considerably
between different markets.
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Previous year figures used for comparable
purposes.
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Gross profit margins for clothes is higher than food.
Establishes whether or not the firm’s trading
position has become more or less profitable.
Any results gained should be looked at in the
context of the industry sector.
Reasons for a fall

Possible reasons for a fall in gross profit
percentage could be:
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Cash losses – theft from sales taking.
Stock losses – theft by staff, shoplifting or wastage.
Price reductions (e.g. having sales).
Increase in cost of goods purchased from suppliers
without a corresponding increase in prices of these
goods sold to customers.
Stocktaking errors.
↑ in goods will not increase the gross profit
percentage.
Altering the Ratio
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Gross profit margin can be improved by:
Raising sales revenue whilst keeping the
cost of sales static or low.
 Reducing the cost of sales (raw materials
used to make the products) made whilst
maintaining the same level of sales revenue
(total money in).
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Interpretation
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A higher percentage result is preferred.
 The net profit margin establishes whether the firm has
been efficient in controlling its expenses.
 Should be compared with previous years figures and
with other companies in the same industry.
 Should also be compared with Gross Profit Margin.

Gross Profit Margin may have improved while Net Profit
Margin declined.

Profits made on trading are rising, but overhead expenses are
increasing at even faster rate and thus cutting into the profits.
Altering the Ratio

Net Profit Margins can be improved by:
Raising sales revenue whilst keeping
expenses low.
 Reducing expenses whilst maintaining the
same level of sales revenue.
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Activities
Thank you for Listening!