3 Profit and loss accounts Every business – however small or large – aims to make a profit. For a business to be able to calculate whether it has made a profit, it must keep a profit and loss account.A profit and loss account summarizes all of a business’s revenue and costs over a period of time, usually a year. The business then uses the figures in it to work out how much profit or loss it made.Possible answers:1. The business can analyse its performance.2. The business can try to forecast its future profits to help it plan whether to change its activities.3. The business’s shareholders can see how well the business is performing.Why is producing a profit and loss account useful for a business?
5 The financial yearBusinesses are legally required by the government to produce annual profit and loss accounts at the end of each financial year for the Inland Revenue.Do you know when the financial year begins and ends in the UK?The UK’s financial year runs from 6 April to 5 April.At the end of each financial year private limited (Ltd) and public limited (PLC) companies must produce audited annual accounts for the Inland Revenue – for it to calculate how much tax they owe.
6 Profit and loss account A profit and loss account can be presented in different ways, but many businesses divide it into three distinct sections:the trading accountthe profit and loss accountthe appropriation account.It can be recorded by hand into an accounts ledger, or entered into a computer spreadsheet or accounts package.
7 1. The trading accountThe first section of the profit and loss account is called the trading account.It shows the revenue the business earned from sales, the cost of production and changes in stock.The business uses this data to work out how much gross profit it has made.
8 The layout of a trading account Answer: The closing stock will become the opening stock in the following year’s trading account.What will the closing stock become in the following year’s trading account?
9 Calculating the trading account Can you remember the formulae needed to complete a trading account?Sales revenue67 865opening stock + purchases - closing stock = cost of salesOpening stock24 514Purchases47 865Closing stock34 217sales revenue - cost of sales = gross profitCost of sales38 162Gross profit29 703
10 Completing a trading account Answers:The cost of sales is purchases (52 145) + opening stock (24 156) – closing stock (31 216) =The gross profit is sales revenue ( ) – cost of sales (45 085) =
11 2. The profit and loss account The second section is called the profit and loss account as it is where the net profit before tax (or loss) is calculated.The profit and loss account records the business’s expenses or overheads so that the operating profit can be calculated.
13 Calculating a profit and loss account Can you remember the formulae needed to complete a trading account?Total expenses = the sum of all the expensesGross profit29 703ExpensesGross profit - total expenses = operating profitSalaries/wages8 246Rent3 456Utilities1 897Equipment965Operating profit - interest on loans = net profit before taxOther587Total expenses15 151Operating Profit14 552Interest on loans1 216Net profit before tax13 336
14 Completing a profit and loss account Answers:The total expenses is the sum of the expenses ( ) =The operating profit is the gross profit (61 915) - total expenses (28 036) =The net profit before tax is the operating profit (33 879) – interest on loans (5 432) =The operating profit is a useful figure for a business to know because it shows the profit from its business activity. Then it can make a judgement about what area to expand/decrease without the figure being clouded by the interest on loans payment.Why is it useful for a business to work out its operating profit?
15 3. The appropriation account The third section of the profit and loss account is the appropriation account. It shows exactly what has happened to the net profit before tax the business made.It shows the tax the business had to pay (corporation tax if it is a company or income tax if not).Then it shows the dividends it paid to its shareholders and any retained profit it kept for reinvestment.
16 The appropriation account Students should be asked to write a one sentence definition of all the terms highlighted on this sheet.Write a sentence to describe each term in your own words.
17 Calculating a trading account Can you remember the formulae needed to complete an appropriation account?Net profit before tax - corporation tax = profit after taxNet profit before tax13 336Corporation tax2 667Profit after tax10 669Profit after tax - dividends = retained profitDividends4 897Retained profit5 772
18 Completing an appropriation account Answers:The profit after tax is net profit before tax (28 447) - corporation tax =The retained profit is profit after tax (22 749) - dividends (9 786) =
21 Profit and loss account activity Complete this profit and loss account by entering the missing values into the coloured cells.To turn the profit and loss account into an Excel spreadsheet, double click on it in ‘normal view’. The answers can be found be clicking on the ‘Sheet2’ tab. The Excel file for this spreadsheet is provided in the Spreadsheets folder on the product CD.
22 Question time! What is another name for a business’s sales revenue? Does the money spent on materials affect the gross profit figure only, the net profit figure only or both profit figures?What is the formula for profit after tax?Which type of profit shows how successful the business activity has been?Answers:Sales turnover, turnover or revenue.It affects both gross profit and net profit.The formula: net profit before tax - corporation tax = profit after tax.Operating profit.
23 Who wants to be an A* student? Answers:revenue and costslossstakeholdersforecastthe Inland Revenue5 April – 6 Aprilbecome investorscompaniescompetitorsdata sharing is easier