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