The Trading Profit and Loss Account

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1 The Trading Profit and Loss Account Businesses usually calculate their profit level by creating a Trading Profit and Loss Account (TPL) The TPL is produced because: It is a legal requirement It summarises all the year s transactions It shows the financial health of the business. Can be used to compare trade this year with trade last year Business Studies Online: Slide 1

2 The Parts of A T,P&L Account The document is made up of 3 sections which must be completed in turn: The The Trading Account This This calculates gross profit. It It takes the the direct costs of of production away from the the sales revenue The The Profit & Loss Loss Account This This takes the the expenses (indirect costs) away from the the gross profit to to calculate net net profit The The Appropriation Account This This shows what will will happen to to any any profit that that has has been made. It It usually refers to to dividends and and taxation Business Studies Online: Slide 2

3 The Structure of a TP&L Account (1) Need to calculate how much it has cost to make the goods that have been sold Value of stock owned at the start of the year Value of raw materials purchased during the year Value of stock left at the end of the year. This will be next year s OPENING STOCK Trading Profit and Loss Statement For Lou Pole, year ending Sales 400,000 LESS Cost of sales Opening Stock 100 Purchases 100, ,100 Less Closing Stock ,000 Gross profit 300,000 Calculated by subtracting cost of sales from sales Business Name and Date Sales, the money from selling goods Business Studies Online: Slide 3

4 The Structure of a TP&L Account (2) Expenses listed and a total given Gross profit 300,000 LESS Expenses Salaries 75,000 Rent 25,000 Other 14,000 Total expenses 114,000 Net profit 186,000 Corporation Tax 74,400 Profit after tax 111,600 Dividends 5,580 Retained profit 106,020 Calculated by subtracting dividends. This is the amount of money that will be kept in the business Calculated by subtracting expenses from Gross Profit Calculated by subtracting tax from net profit Business Studies Online: Slide 4

5 Different Types of T,P & L Accounts The T,P & L Accounts of businesses will differ according to their legal structure Companies (Ltds & Plcs) are subject to more legal constraints: The Accounts Of Incorporated Businesses Accounts must be published Accounts usually show figures for 2 years They must show how the profit is being used (Appropriation Account) Business Studies Online: Slide 5

6 The Limitations Of T,P & L The trading, profit & loss account is a historical view of the business It does not tell us what will happen in the future although it may help to identify trends Businesses may manipulate accounts in order to reduce their tax liabilities, or to deter a potential takeover Business Studies Online: Slide 6

7 Working Capital Working capital refers to the materials that a business needs in order to make the products that it sells Without working capital a business would be unable to operate It is the working capital that produces profit and as such it is referred to as an investment However, working capital items are NOT intended to be kept by the business Business Studies Online: Slide 7

8 How Money Works In Business Money constantly goes round a business in a cycle This can be shown as follows: Business Studies Online: Slide 8

9 The Speed of the Working Capital Cycle If the amount of cash at the end of the cycle is bigger than that at the start then a firm will make a profit How much profit depends upon how quickly they can get round this cycle. How quickly it can get round depends on two factors: Speed of The Working Capital Cycle Creditors Debtors People a business owes money to. They speed up the cycle People who owe the business money. They slow down the cycle. Business Studies Online: Slide 9

10 Calculating the Working Capital The working capital of a firm is calculated as follows: Working Capital = Current Assets Current Liabilities Where: Current Assets = Anything a business owns, which it intends to sell Examples include raw materials, stock, debtors and cash. Current Liabilities = Anything that a business owes, which must be paid within the next 12 months Examples include creditors, overdraft and dividends. This calculation is part of the BALANCE SHEET Business Studies Online: Slide 10

11 What is a Balance Sheet? A Balance Sheet is a financial statement which shows the ASSETS, LIABILITIES and CAPITAL of a business on a particular date Assets Are Are items items owned owned by by the the business or or owed owed to to the the business Capital Is Is the the money money invested by by the the owners owners or or shareholders Liabilities Are Are amounts owed owed by by the the business Business Studies Online: Slide 11

12 The Key Principle of a Balance Sheet Businesses can only spend money that they either have, or have borrowed then: All Assets must equal All Liabilities Business Studies Online: Slide 12

13 The Structure of a Balance Sheet (1) Business Name and Date Balance Sheet For A.B.Hive LTD as at 31 December 2004 Fixed assets Fixed Assets Building are listed and 170,000 then added up. Equipment 60, ,000 Current assets Stock 30,000 Debtors 10,000 Cash at bank 5,000 45,000 Current Assets are listed and totalled Business Studies Online: Slide 13

14 The Structure of a Balance Sheet (2) Current Liabilities listed and totalled Current liabilities Trade creditors 25,000 Calculated by current assets current liabilities Net Current Assets 20,000 OR Working Capital Less Long Term Liabilities Mortgage 45,000 Loan 5,000 50,000 Calculated by fixed assets + working capital long term liabilities Net Assets 200,000 Long Term liabilities are listed and totalled, then taken away Business Studies Online: Slide 14

15 The Structure of a Balance Sheet (3) This section shows FINANCED BY: where the money in the business has come from. Capital and reserves Share capital 75,000 Profit and loss account 125,000 Total Capital Employed 200,000 This means that 200,000 has been invested in the business Business Studies Online: Slide 15

16 Who Uses A Balance Sheet? Both the balance sheet and the profit and loss account show the health of the business All the stakeholders will be interested in the balance sheet, but especially: Shareholders Customers Suppliers Employees When used with the Trading Profit and Loss account it shows how well the business is doing Business Studies Online: Slide 16

17 The Limitations Of The Balance Sheet As soon as it is produced it is out of date Fixed assets may be over valued if they are depreciated incorrectly Businesses are not required to include intangible assets such as brand names. This can understate the value of the company Companies tend not to give a breakdown of the figures they just quote totals Business Studies Online: Slide 17

18 Differences In Accounts Different types of business produce different types of accounts, due to legal requirements: Unincorporated Businesses Must produce accounts for taxation purposes Are usually in a simple format T, P & L A/C will not have an Appropriation Account Incorporated Businesses Must publish accounts Often abbreviated so competitors get limited information Usually show 2 years figures Some terminology is changed Business Studies Online: Slide 18

19 Share Capital Vs Loan Capital There is a big difference between share capital and loan capital: Share Capital The total amount invested in a business by shareholders Note that share capital is NOT the same as Shareholders funds Loan Capital Is medium long term finance provided by: Banks Debentures Other lenders Business Studies Online: Slide 19

20 Share Capital Vs Shareholders Funds Any profits invested in a business belong to it s shareholders As such Shareholders funds can be calculated as: Shareholders Funds = Share Capital + Reserves Business Studies Online: Slide 20

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