The Trading and Profit & Loss Account

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1 Page 1 di 16 3(3(63,==$ from The Trading and Profit & Loss Account One of the most important uses of the Trading and The Profit and Loss account is to compare the results obtained with the results expected. There are two profit measures: 7KH*URVV3URILW This is calculated in the Trading Account and is the excess of sales over the cost of goods sold during the period. 7KH1HW3URILW This is calculated in the Profit and Loss Account and is what remains after all other costs used up in the period have been deducted from the Gross Profit. It is now usual for the trading and the Profit and Loss accounts to be shown under one combined heading, The Trading Account being the top section and the Profit and Loss account being the lower section. It would be unusual for a trader to have sold all the goods at any particular date. So in most cases there would be stock in hand at the end of the trading period. So it is normal practice for this stock to be counted and valued at the price for which it could be sold. The figure for this is normally called the closing stock and the details are given as a note at the end of the 7ULDO %DODQFH. This amount is in fact entered as a debit in a new account called the Stock account, which is an asset account and as a credit in the Trading account. The Trading Account also shows any items of expenditure which can properly be allocated to expenses connected with the purchase, manufacture or stage of goods, i.e. rent of warehouse, wages of store men, carriage inwards, etc. 2WKHUFRQVLGHUDWLRQV 5HWXUQV2XWZDUGV - Goods returned to suppliers, so this reduces the cost of purchases. 5HWXUQV,QZDUGV - Goods returned to the company by the customers who bought them, so this reduces the sales figure. &DUULDJH,QZDUGV - Is the cost of transport of goods into the firm and are therefore added to the purchases figure. &DUULDJH2XWZDUGV - Is the cost of transport of goods out of the firm to its customers, it is not part of the firm s expenses in buying the goods and is always entered in the Profit and Loss Account as an expense not the Trading Account.

2 Page 2 di 16 'HSUHFLDWLRQ - This is discussed later, but generally the provision for depreciation for the accounting period is considered an expense to the business is entered on the Profit and Loss Account. ( The total depreciation of the asset is taken account of on the Balance Sheet). 7KLVLVWKH3HSHV7UDGLQJDQG3URILWDQG/RVV$FFRXQWIRUWKH\HDUHQGLQJ 6$/(6 PLQXV5HWXUQV,QZDUG PLQXV&2672)6$/(6 RSHQLQJ6WRFN SOXV3XUFKDVHV PLQXV5HWXUQV2XWZDUG SOXV&DUULDJH,QZDUGV PLQXV&ORVLQJ6WRFN * ),7 /(66(;3(16(6 ZDJHV OLJKWDQGKHDW SULQWLQJDQGVWDWLRQDU\ WHOHSKRQH FDUULDJHRXWZDUGV DGYHUWLVLQJ RYHUKHDGV GLVFRXQWDOORZHG PRWRULQJH[SHQVHV LQWHUHVWSD\DEOH 3/8627+(5,1&20( FRPPLVVLRQUHFHLYHG GLVFRXQWUHFHLYHG 1(7352),7 NOW LETS MOVE ONTO THE BALANCE SHEET

3 Page 3 di 16 The Balance Sheet The Balance Sheet is a list of the balances remaining on the Trial Balance after the Trading & Profit & Loss account has been done. The balances are arranged according to whether they are asset balances or liability or capital balances and gives the business s financial position at any given point in time. The Balance sheet is normally described " as at ". It is a snapshot at one particular point in time. The balance sheet can be prepared in two formats: 9HUWLFDOO\, emphasising Assets - Liabilities = Capital or +RUL]RQWDOO\, emphasising Assets = Capital + Liabilities For the purposes of this exercise we will be using the vertical format, as this is most widely used in all types of businesses and its form of presentation makes comparisons with other years easier. To recap: $66(76 There are two types of assets: )L[HGDVVHWV are the more or less permanent assets of the business. They are not normally for resale, e.g. premises, motor vehicles, fixtures and fittings, equipment and furniture. &XUUHQWDVVHWV are the types of assets used for trading purposes. These assets are usually more liquid than the fixes assets. In other words they are more readily converted into cash. They include cash, bank, debtors and stock. /,$%,/,7,(6 There are two main types of liabilities: /RQJWHUPOLDELOLWLHV and are the creditors payable after 12 months. They include mortgages, loans, hire purchase repayments longer than 12 months and debentures. &XUUHQWOLDELOLWLHV represent the debts of the business which have to be paid in less than 12 months. These include trade creditors, bank overdrafts, and short-term loans that are repayable within 12 months. &$3,7$/ Capital represents what is known as " WKHQHWZRUWK" of the owner(s). It is the difference between the assets and the liabilities. In the Balance Sheet it is listed under the ")LQDQFHG%\ section. It includes capital introduced into the business, (which could be personally from the owners if a sole trader or partnership, or from the shareholders if a limited company), the net profit for the accounting period, less any owners drawings. Now lets look at completing 3HSHV%DODQFHVKHHW

4 Page 4 di 16 The Balance Sheet This is the basic outline of a Balance Sheet : ),;('$66(76 Premises Equipment Machinery &855(17$66(76 Stock Debtors Bank Petty Cash /(66&855(17/,$%,/,7,(6 Creditors Bank Overdraft $/ &$3,7$/(03/2<(' less mortgage ),1$1&('%< net profit capital less drawings % $/ 6ROHWVFRPSOHWH3HSHV%DODQFH6KHHW

5 Page 5 di 16 The Balance Sheet 7KLVLVWKHFRUUHFWYHUVLRQRI3HSHV%DODQFH6KHHWDVDW ),;('$66(76 Premises 100,000 Equipment 8,000 Machinery Motor Vehicle 20, ,000 &855(17$66(76 Stock 5,500 Debtors 7,600 Bank ---- Petty Cash ,300 /(66&855(17/,$%,/,7,(6 Creditors 5,000 Bank Overdraft 2,000 (7,000) 6,300 &$3,7$/(03/2<(' 134,300 less mortgage 70,000 ),1$1&('%< FDSLWDO 53,000 QHWSURILW 19,300 72,300 OHVVGUDZLQJV (8,000) However for most businesses there is an item called '(35(&,$7,21 that has to be accounted for. Lets see how this would affect both the Trading & Profit and Loss Account as well as the Balance Sheet. 'HSUHFLDWLRQ Fixed assets are those assets of the business that have a long life, are used in the business and are not for re-sale or for conversion to cash, e.g. motor vehicles, machinery, buildings, land, office equipment, etc. However, usually, except for land, most fixed assets have a limited number of years of useful life. Depreciation can be defined, in its simplest terms, as the difference between the original cost of the asset and the amount received when the asset is sold, for example, if Pepe buys a motor vehicle for 20,000 and then sells it for 8,000, then the total depreciation is 12,000. If an asset is bought and sold within one accounting period, (normally one trading year) then the depreciation can be accounted for within one accounting period. However difficulties arise because most assets are used for more than one accounting period. Pepe is planning to keep his vehicle for four years.

6 Page 6 di 16 In this instance there are two main methods of calculating the SURYLVLRQIRUGHSUHFLDWLRQ VWUDLJKW OLQH and UHGXFLQJEDODQFH. The choice of which method to use depends upon whether the main value to the business of the asset is gained evenly throughout the life of the asset or whether it is gained mainly in the early years of the asset when it is newer and the repairs and maintenance costs are lowest. 7KH6WUDLJKW/LQH0HWKRGRI&DOFXODWLQJ'HSUHFLDWLRQ This allows an HTXDO amount to be charged as depreciation for each year of the expected use of the asset. The basic formula is: 25,*,1$/&267(67,0$7('&267:+(162/'122)<562)(;3(&7('86(3529,6,213(5<5 '(35(&,$7,21 In Pepe s case, he paid 20,000 for a motor vehicle. He expects to use it for four years before he replaces it. He estimates that when he sells it in four years time he will get 8,000 for it. So, for Pepe, the calculation for the provision for depreciation would be: SHU\HDU The figures from which to calculate the depreciation are normally given as a note at the end of the Trial Balance. This means that within the accounts there must be both a credit and debit entry. So the Provision for depreciation )257+$7<($5 is added as an expense on the Trading & Profit & Loss Account. 7UDGLQJDQG3URILW /RVV$FFRXQW This is the revised TRADING and PROFIT & LOSS account, including the PROVISION FOR DEPRECIATION, calculated using the Straight-Line Method. 6$/(6 PLQXV5HWXUQV,QZDUG 0,186&2672)6$/(6 RSHQLQJ6WRFN SOXV3XUFKDVHV PLQXV5HWXUQV2XWZDUG SOXV&DUULDJH,QZDUGV PLQXV&ORVLQJ6WRFN * ),7 /(66(;3(16(6 ZDJHV OLJKWDQGKHDW SULQWLQJDQGVWDWLRQDU\ WHOHSKRQH FDUULDJHRXWZDUGV DGYHUWLVLQJ RYHUKHDGV GLVFRXQWDOORZHG PRWRULQJH[SHQVHV SURYLVLRQIRUGHSUHFLDWLRQ LQWHUHVWSD\DEOH 3/8627+(5,1&20( FRPPLVVLRQUHFHLYHG GLVFRXQWUHFHLYHG 1(7352),7 1RZOHWVPRYHRQWRWKHEDODQFHVKHHW

7 Page 7 di 16 7KLVLVWKHUHYLVHGYHUVLRQRI3HSHV%DODQFH6KHHWDVDWXVLQJWKH6WUDLJKW OLQH0HWKRGRIFDOFXODWLQJ'HSUHFLDWLRQ cost GHSUHFLDWLRQ Premises 100, ,000 Equipment 8, ,000 Machinery Motor Vehicle 20, ,000 &855(17$66(76 Stock 5,500 Debtors 7,600 Bank ---- Petty Cash /(66&855(17/,$%,/,7,(6 Creditors 5,000 Bank Overdraft 2,000 (7,000) 6,300 &$3,7$/(03/2<(' 131,300 less mortgage 70,000 61,300 ),1$1&('%< capital 53,000 net profit 16,300 69,300 less drawings (8,000) 61,300 7KH5HGXFLQJ%DODQFH0HWKRGRI&DOFXODWLQJ'HSUHFLDWLRQ This method calculates the Provision for Depreciation annually on the balance of the asset from the previous year. It is normal for the percentage to be used to be specified in the notes at the end of the Trial Balance. This method is particularly useful for assets where the repair and maintenance costs increase as the asset gets older, for example on a motor vehicle. By reducing the Provision for Depreciation as the repair and maintenance cost rise, means that the total usage costs each year are kept fairly constant. So, if Pepe s Accountant recommends using the Reducing Balance Method for calculating the Provision for Depreciation for his motor vehicle, assuming 20%, the figures would be: <($5 SXUFKDVHSULFH OHVV RI 3URYLVLRQIRU'HSUHFLDWLRQ<HDU DVVHWYDOXHDWWKHHQGRI\HDU <($5 DVVHWYDOXHDWWKHHQGRI\HDU OHVV RI 3URYLVLRQIRU'HSUHFLDWLRQ<HDU DVVHWYDOXHDWWKHHQGRI\HDU <($5 DVVHWYDOXHDWWKHHQGRI\HDU OHVV RI 3URYLVLRQIRU'HSUHFLDWLRQ<HDU DVVHWYDOXHDWWKHHQGRI\HDU

8 Page 8 di 16 <($5 DVVHWYDOXHDWWKHHQGRI\HDU OHVV RI 3URYLVLRQIRU'HSUHFLDWLRQ<HDU DVVHWYDOXHDWWKHHQGRI\HDU The Provision for Depreciation, -867)257+,6$&&2817,1*3(5,2' is an expense on the Trading & Profit and Loss Account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

9 Page 9 di 16 7KLVLVWKHUHYLVHGYHUVLRQRI3HSHV%DODQFH6KHHWDVDWXVLQJWKH5HGXFLQJ %DODQFH0HWKRGWRFDOFXODWHWKHGHSUHFLDWLRQ cost GHSUHFLDWLRQ Premises 100, ,000 Equipment 8, ,000 Machinery Motor Vehicle 20, ,000 &855(17$66(76 Stock 5,500 Debtors 7,600 Bank ---- Petty Cash /(66&855(17/,$%,/,7,(6 Creditors 5,000 Bank Overdraft 2,000 7,000 6,300 &$3,7$/(03/2<(' 130,300 less mortgage 70,000 60,300 ),1$1&('%< capital 53,000 net profit 15,300 68,300 less drawings (8,000) 60,300 3URILWDELOLW\6ROYHQF\DQG3HUIRUPDQFH5DWLRV Once the accounts have been done, and are ready to be published. A number of people might want to compare them with other companies operating in the same financial sector. How do they do this? The answer is to use SURILWDELOLW\VROYHQF\DQGSHUIRUPDQFHUDWLRV These are quite simple formulae which help to create a picture of the company. This worksheet identifies the name of the ratio, the formula, where we should be looking in the accounts and what it means. These ratios are not by themselves the answer to all questions, but an indicator of areas requiring further examination. Try some out! Have a go with the figures from Pepe s Pizza Parlour. Please note: The symbol means divide by.

10 Page 10 di 16 Profitability How successful a company is depends upon its profitability. The key ways in which we work out these are called the 5HWXUQRQ&DSLWDO(PSOR\HG and the *URVVDQG1HW3URILW0DUJLQV Return on Capital Employed (ROCE) This is expressed in percentage terms and is often called "return on owner's equity". It represents the profit earned from the money invested in the business by it's owner. It can be worked out by the following equation: 1HW3URILWEHIRUH,QWHUHVWDQGWD[&DSLWDO(PSOR\HG[ So a company generating a net profit of 250,000 before deduction of interest and tax which has an opening balance on it's capital account 1M would have a Return on Capital of 25%. Gross and Net Profit Margins These are the most commonly used profitability ratios. They express the comparison between sales and profit in percentage terms, and are worked out by the following equations: *URVV3URILW0DUJLQ *URVV3URILW6DOHV[ 1HW3URILW0DUJLQ 1HW3URILW6DOHV[ So, if the company which generated a net profit of had achieved sales of the profit margin would be 33%. Solvency The solvency or liquidity of a company tells us whether a company can pay its debts. We work how solvent companies are by using the /LTXLGLW\5DWLRV Liquid Ratio (or Acid test) This ratio is calculated as follows: /LTXLGDVVHWV&XUUHQWOLDELOLWLHV Liquid assets are those assets which can be turned into cash quickly such as debtors, cash and short term investments such as bank deposits. Stock is QRW considered a liquid asset. Current liabilities are those liabilities which must be paid shortly such as creditors DQG bank overdrafts. A bank overdrafts is considered to be a current liability because it can be recalled without notice. The ideal ratio should be around 1:1. If, for example, a company had liquid assets of 60,000, and debts of 40,000 the ratio would be: Expressed as

11 Page 11 di 16 This means that the company has more assets ( than liabilities (1). This company is solvent but may not be managing it s money very well. If the figures were reversed then the ratio would change as follows: Expressed as This would mean that the company is in serious trouble since it would not have sufficient funds to meet its liabilities. Current or Working Capital ratio This is the other test of a companies liquidity. It takes a longer term view of the company s position since unlike the Acid test it includes stock and work in progress ( this is termed &XUUHQW DVVHWV). This is due to the fact that it is deemed that both of these will at sometime be turned into debts and eventually into cash. The ratio is worked out as follows: &XUUHQWDVVHWV&XUUHQWOLDELOLWLHV therefore a company with current assets of 80,000 with the current liabilities of 40,000 would equate as follows: and would be expressed as. There is no "ideal" ratio but a figure of 2:1 is often quoted. Most businesses operate with a ratio lower than this but it is important to maintain a healthy figure because bank overdrafts can in theory be recalled without notice at any time. Performance These ratios provide information on how well a business is being run. Rate of Stock turnover Businesses try to have as high a rate of stock turnover as possible. The rates can be expressed in two ways. $YHUDJHVWRFN&RVWRIJRRGVVROG[HLWKHURU This tells a business how long on average an item remains in stock. The figure can be expressed in terms of months, weeks or days. For Pepe's Pizza Parlour, this would result in the following: 4,750 / 39,500 x 365 = 44 days (on average) &RVWRIJRRGVVROG$YHUDJHVWRFN

12 Page 12 di 16 This tells a business how many times in each year the stock rotates. For Pepe s Pizza Parlour, this would result in the following: LH7KHVWRFNLVFOHDUHGWLPHVD\HDU Note! In both cases the average stock can be calculated from the Trading and Profit and Loss account by: Debtors collection period 2SHQLQJVWRFN&ORVLQJVWRFN For Pepe s Pizza Parlour this is 4, ,500 / 2 = 4,750. Most businesses sell goods on credit. Credit is usually given for periods of 30, 60 or 90 days. No business wishes to extend the credit period given and so it is important to monitor just how long customers are taking to pay for credit sales. The following ratio can be used: 'HEWRUV$YHUDJHGDLO\VDOHV6DOHVGLYLGHGE\ Creditors payment period It is important for a business to monitor how long it takes to pay it s creditors. Persistent late payment may result in a supplier cutting off credit facilities! The following ratio can be used: &UHGLWRUV$YHUDJHGDLO\SXUFKDVHV3XUFKDVHVGLYLGHGE\ Gearing (income gearing) Gearing is the name given to the ratio which measures how much of a company s profits are taken up by interest payments. It is expressed as a percentage, and is worked out by:,qwhuhvw3urilw[ Therefore a company with interest payments of 35,000 whilst earning 50,000 would have the following gearing ratio: [ This company would be susceptible to changes in the interest rate. Whereas a company with a gearing ratio of 40% could absorb any increases in the interest rate with greater ease. A Test paper based upon these ratios is available. (You will need to print off a copy of Pepe's Trading and profit and Loss Account and Pepe's Balance Sheet if you wish to do this test paper)

13 Page 13 di 16 5HWXUQRQ&DSLWDO(PSOR\HG52&( 1HW3URILWEHIRUHLQWHUHVW WD[ &DSLWDO(PSOR\HG [ 52&( *URVV3URILW0DUJLQ *URVV3URILW 6DOHV [ *URVV3URILWPDUJLQ 1HW3URILW0DUJLQ 1HW3URILW 6DOHV [ 1HW3URILWPDUJLQ /LTXLGLW\5DWLRRU$FLGWHVW /LTXLGDVVHWV &XUUHQWOLDELOLWLHV $FLGWHVW &XUUHQW5DWLR &XUUHQWDVVHWV &XUUHQWOLDELOLWLHV &XUUHQWUDWLR *HDULQJLQFRPHJHDULQJ,QWHUHVW 3URILW,QFRPHJHDULQJ

14 Page 14 di 16 'R\RXZDQWWRVHHWKHDQVZHUV"'RQWIRUJHWWRSULQWWKLVSDJHVRWKDW\RXFDQVHHKRZ \RXGLG Answers 5HWXUQRQ&DSLWDO(PSOR\HG 1HW3URILW &DSLWDO(PSOR\HG [ 52&( EHIRUHLQWHUHVWDQGWD[ (interest) % *URVV3URILW0DUJLQ *URVV3URILW 6DOHV [ 3URILWPDUJLQ % 1HW3URILW0DUJLQ 1HW3URILW 6DOHV [ 3URILWPDUJLQ % /LTXLGLW\5DWLRRU$FLGWHVW /LTXLGDVVHWV &XUUHQWOLDELOLWLHV $FLGWHVW : 1 &XUUHQW5DWLR &XUUHQWDVVHWV &XUUHQWOLDELOLWLHV &XUUHQWUDWLR : 1 *HDULQJLQFRPHJHDULQJ,QWHUHVW 1HW3URILWEHIRUHGHGXFWLQJ,QFRPH LQWHUHVWDQGWD[ JHDULQJ (interest) 0.01(1%)

15 Page 15 di 16 (1*/,6+ account for advertising Average stock bank overdraft Carriage inwards Carriage outwards clear Creditors payment period Customer debentures Debtors collection period Deem Depreciation Ease emphasise equate Expected fixtures and fittings Furniture Gearing Gross profit Heading healthy figure light and heat Mortgage On average Opening balance outline Overheads Parlour Performance Petty Cash Printing and stationery Profit measures Profitability Provision for depreciation Rate of Stock turnover Ratio readily recalled without notice recap Reducing balance method of depreciation Return Returns Inwards Returns Outwards sales figure Snapshot Solvency Store man Straight line method of depreciation the net worth,7$/,$1 Render conto, contabilizzare Pubblicità Consistenza media scoperto di banca (conto corrente) Spese di trasporto degli acquisti Spese di trasporto delle vendite Smaltire Dilazione media dei debiti Cliente Obbligazioni Periodo di incasso dei crediti giudicare, pensare, stimare Ammortamento Facilità, sollievo Enfatizzare Identificare, esprimere in forma di equazione Atteso, previsto Attività fisse Arredamento Rapporto di indebitamento Profitto lordo, Margine lordo Titolo, intestazione, dicitura Dato equilibrato Luce e riscaldamento Mutuo In media Bilancio di apertura Schema Spese generali bottega, salotto Rendimento, risultato fondo per le piccole spese Stampati e cancelleria Misure/grandezze del profitto Redditività Fondo ammortamento Indice di Rotazione del magazzino Indice, rapporto Prontamente Revocati senza preavviso Ricapitolare Ammortamento a quote decrescenti Guadagno Resi da clienti Resi a fornitori Ammontare delle vendite Foto istantanea Solvibilità Magazziniere Ammortamento a quote costanti Capitale netto (patrimonio netto)

16 Page 16 di 16 Trading Account trading year Trial Bilance Try out useful life Whereas whilst work in progress Work out Conto dell esercizio commerciale Periodo amministrativo Bilancio di verifica Provare, sperimentare Vita utile Mentre, premesso che, considerato che Mentre, allo stesso tempo, finchè Prodotti in corso di lavorazione Risolvere

PREPARING FINAL ACCOUNTS. part

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