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3. Finance3.2 Profit and Loss Accounts and Balance Sheets
3.2 Profit and Loss Accounts and Balance Sheets
IF I BORROW A MILLION POUNDS AM I A MILLIONAIRE?
Revisiting unit 1• In unit 1 you looked at some basic financial terms
and calculations – can you remember these?•Roger sells 2000 pairs of jeans at £35 per
pair▫What is his sales revenue?
•He buys each pair of jeans from a wholesaler for £15▫What are his variable costs?▫How much profit does he have so far?
• In addition he has to pay overheads of £10000▫How much profit does he have left now?
3.2 Profit and Loss Accounts and Balance Sheets
In unit 2 you are going to look at how a business presents this and other information in its accounts.
3.2 Profit and Loss Accounts and Balance Sheets•In this topic you will learn about:
▫Purpose of financial statements▫Components of financial statements▫Interpretation of data given on financial
statements
3.2 Profit and Loss Accounts and Balance Sheets
What are financial statements?•A business has to record all transactions of
money going into and out of the business•These transactions form a numerical history of
the business and are summarised in the financial statements
•These statements show whether the business has made a profit or a loss and how much it is worth
•The two financial statements you will look at here are▫Profit and Loss Account▫Balance Sheet
3.2 Profit and Loss Accounts and Balance Sheets
Purpose of financial statements
•Keeps the business and other stakeholders informed about the businesses performance▫Identifies whether the business is making a
profit or a loss▫Shows how much the business is worth
•Tracks the flow of cash into and out of the business
•Informs managers on the payment of suppliers and receipts from customers
•Helps inform future decisions
3.2 Profit and Loss Accounts and Balance Sheets
Different stakeholders will want to view financial statements for varying reasons• In pairs think about why each group of stakeholders might be
interested in the financial statements of a business
3.2 Profit and Loss Accounts and Balance Sheets
Stakeholder Group Reason for Interest
Shareholders
Employees
Suppliers
Customers
Bank
Government
Profit and Loss Account• Shows a summary of a firm’s trading and expenses in a
given time period (normally a year) in order to identify whether the firm has made a profit or a loss
• The components are:▫ Sales Revenue
The total amount of money achieved as a result of selling goods or services
▫ Cost of Sales The costs which are directly related to producing the goods or
services sold e.g. Raw materials▫ Gross Profit
Sales Revenue minus Cost of Sales▫ Expenses
All other costs experienced by the firm, also called overheads▫ Net Profit
Gross Profit minus Expenses
3.2 Profit and Loss Accounts and Balance Sheets
Profit and Loss AccountA sample Profit and Loss Account for Nuts and Bolts Ltd
£msSales Revenue 650Cost of Sales 325Gross Profit 325Expenses 247Net Profit 78
3.2 Profit and Loss Accounts and Balance Sheets
Interpretation of a P&L a/c▫To interpret accounts we use simple ratios; this
means comparing one figure to another What is the ratio of students to teacher in your
class? What is the ratio of empty seats to full seats?
What would each of these answers be expressed as a percentage?
▫In accounts there are two ratios used here to interpret a P&L a/c Gross profit margin
Shows gross profit as a percentage of sales revenue Net profit margin
Shows net profit as a percentage of sales revenue
3.2 Profit and Loss Accounts and Balance Sheets
Interpretation of a P&L a/cGross Profit Margin Net Profit Margin
Gross Profit x 100Sales Revenue
Nuts and Bolts Ltd
£325m x 100 = 50%£650m
What does this mean?For every £1 made in sales 50p is left as gross profitA very low gross profit margin may indicate that the cost of sales is too high in relation to selling price
Net Profit x 100Sales Revenue
Nuts and Bolts Ltd
£78m x 100 = 12%£650m
What does this mean?For every £1 made in sales 12p is left as net profitA very low net profit margin may indicate that the cost of sales and or expenses are too high in relation to selling price
3.2 Profit and Loss Accounts and Balance Sheets
Profit and Loss Account▫Rearrange the information below to produce a
completed Profit and Loss account for Charlie Fashion Ltd (neither the numbers or headings are in the correct order)
▫Gross Profit = £27m▫Net Profit = £4.5m
3.2 Profit and Loss Accounts and Balance Sheets
£ms
Expenses Sales revenue
Gross profit
Net profit Cost of sales
£27m £63m £4.5m £90m £22.5m
Calculate the Gross Profit Margin
(Gross Profit/ Sales Revenue x 100)
and Net Profit Margin (Net Profit/Sales Revenue x 100) for Charlie Fashion Ltd
Profit and Loss AccountThe directors of Charlie Fashion Ltd are concerned about how the business is performing. The following data has been taken from the last 2 years company accounts.
Question Time1. Calculate the percentage change in sales revenue between
2010 and 2011. (2 marks)
2. Calculate the Gross and Net Profit Margins for 2011. Show your workings. (4 marks)
3. To what extent do you think that the directors are right to be concerned about the financial performance of Charlie Fashion Ltd? (9 marks)
3.2 Profit and Loss Accounts and Balance Sheets
2010 2011
Sales Revenue £90m £83m
Gross Profit £27m (GPM 30%) £25.5m
Net Profit £4.5m (NPM 5%) £5.1m
Balance Sheet• Shows a summary of everything a business owns (its
assets) and what it owes (its liabilities) in order to calculate the net worth of the business at a set point in time
• The components are: (Part 1)▫Fixed Assets
Items owned by the business that it will keep for more than one year e.g. Premises
▫Current Assets Items owned by the business that are to be sold or used
within one year e.g. stock▫Current Liabilities
Items the business owes that are to be paid back within one year e.g. An overdraft
▫Long term liabilities Items the business owes that are to be paid back in over one
year e.g. Bank loan
3.2 Profit and Loss Accounts and Balance Sheets
Balance Sheet• Part 1 of the balance sheet shows where money
is tied up in the business in assets, and where it is owed in liabilities.
• The liabilities are deducted from the assets to give the Net Assets▫This figure indicates the worth of the business
• But where did the money come from to create this worth? This is shown in part 2
• The components are: (Part 2) Capital and Reserves▫Shares Issued
Capital raised by the sale of shares▫Retained Profit
Profit kept by the business
3.2 Profit and Loss Accounts and Balance Sheets
A Sample Balance Sheet for Nuts and Bolts Ltd
Fixed Assets £msPremises 15Equipment 130Machinery 200Vehicles 55 400Current AssetsStock 174Debtors 109Cash 17 300Current LiabilitiesCreditors 145Overdraft 55 200Net Current Assets 100 CA – CLTotal Assets less Current Liabilities 500 FA+CA-CLLong Term LiabilitiesBank Loan (95)Net Assets 405 TA – CL- LTLCapital and ReservesShares Issued 125Retained profit 280 405
3.2 Profit and Loss Accounts and Balance Sheets
Interpretation of a Balance Sheet▫To interpret accounts we use simple ratios; this
means comparing one figure to another Here we compare Current Assets to Current
Liabilities This measures the liquidity of the business i.e. Its
ability to meet day to day expenditure Does it have enough money to pay the bills?
▫In accounts there are two ratios used here to measure liquidity Current ratio
Expresses current assets in relation to current liabilities
Acid Test A tougher measure that expresses current assets,
excluding stock, in relation to current liabilities
3.2 Profit and Loss Accounts and Balance Sheets
Interpretation of a Balance SheetCurrent Ratio Acid Test
Current AssetsCurrent Liabilities
Nuts and Bolts Ltd
£300m x = 1.5£200m
What does this mean?For every £1 in liabilities, short term debts, the firm has £1.50 with which to pay them from current assetsLiquidity is healthy
Debtors + CashCurrent Liabilities
Nuts and Bolts Ltd
£109m+ £17m = 0.63£200m
What does this mean?For every £1 in liabilities, short term debts, the firm has only £0.63 with which to pay them from current assets, excluding stockLiquidity is a concern
3.2 Profit and Loss Accounts and Balance Sheets
Balance Sheet• Replace each letter a - g with the correct figure
Fixed Assets £msFixed Assets 62 62Current AssetsStock 20Debtors aCash 9 44Current LiabilitiesCreditors 35Overdraft 5 bNet Current Assets cTotal Assets less Current Liabilities d Long Term LiabilitiesBank Loan (4)Net Assets eCapital and ReservesShares Issued 26Retained profit f g▫ Calculate the current ratio and acid test
3.2 Profit and Loss Accounts and Balance Sheets
Balance Sheet
The directors of Charlie Fashion Ltd are concerned about the liquidity of the business. In 2010 the current ratio was 1.1 and the acid test 0.6. The following data has been taken from the last 2 years company accounts.
Question Time1. What is meant by the term ‘liquidity’? (2 marks)2. Calculate the Current Ratio and Acid Test for 2011. Show your
workings. (4 marks)
3. To what extent do you think that the directors are right to be concerned about the liquidity of Charlie Fashion Ltd? (9 marks)
3.2 Profit and Loss Accounts and Balance Sheets
2011 2010
Stock £25m £20m
Debtors £28m £15m
Cash £7m £9m
Current Liabilities £50m £40m
30 Second Challenge
End
How many items on a balance sheet can you
name?Starting NOW
True or False?• Net profit is higher than gross profit• Gross profit is sales revenue minus cost of sales• Overdrafts appear on a P&L a/c• Current assets are always higher than current
liabilities• Debtors are a current asset• Stock is a current liability• The acid test is lower than the current ratio• Premises are a fixed asset• Bank loans are a current liability• Net profit margin is sales revenue/net profit x
100
3.2 Profit and Loss Accounts and Balance Sheets
5 Minute Test•Name 2 financial statements•What is an asset?•What is a liability?•Name 2 fixed assets•What is a debtor?•What is the difference between a current
liability and a long term liability?•What are the 5 components of a P&L a/c,
in order? End
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