Income statements Lesson outcome: Understand the main elements of an income statement Interpret a simple income statement Use income statements as an aid to decision making

Profit and Loss Account Mr Reading's Burger Bar   2007 2008 £OOO Sales (Turnover) 300 350 Cost of Sales Opening Stock 40 30 Purchases 120 145 160 175 Less Closing Stock 35 130 140 Gross Profit 170 210 mbnj Less expenses Wages 50 55 Insurance 2 3 Rates 11 12 Rent Telephone Advertising 4 5 Depreciation IT Light and heat 75 8 118 135 Profit 52 Corporation Tax 17 Profit After Tax 58 Divends paid 15 20 Retained profit carried forward 25 28 Trading Account Profit and Loss Account Appropriation account

The income statement serves several important purposes: Allows shareholders/owners to see how the business has performed and whether it has made an acceptable profit (return) Helps identify whether the profit earned by the business is sustainable Enables comparison with other similar businesses (e.g. competitors) and the industry as a whole Allows providers of finance to see whether the business is able to generate sufficient profits to remain viable (in conjunction with the cash flow statement) Allows the directors of a company to satisfy their legal requirements to report on the financial record of the business

What is Income statement all about? The Income statement is actually 3 different things all rolled into one! The names of these 3 sections are: Trading Account Profit and Loss Account Appropriation Account

To keep things simple, the Income statement looks at all of the things that you have bought and sold across a year and takes away all of the costs you had to pay during that year.

If you make more money than you have to pay out you are in profit If you pay out more than you make then you are in loss.

Ok so what is a Trading Account? The Trading Account is used to calculate the amount of GROSS PROFIT that a business makes.

Let’s show you what this actually means using Sidney the Dodgy Salesman to help us out. I have made £35,000 in sales during this year. Sidney has enjoyed a good year but we now need to work out how much these items cost him to buy to help us calculate his profit.

Remember that this is Sidney’s Sales Revenue and it is NOT his profit!

OPENING STOCK At the start of the year, Sidney’s warehouse was almost empty. He only had £1,000 worth of goods left.

Blimey I need to buy more stock and quickly! PURCHASES Sidney bought £12,000 worth of new goods during the year which he intended to sell to the general public.

FULL WAREHOUSE!

CLOSING STOCK At the end of the year I have got only £2,000 worth of stock left in my warehouse. Closing stock is the value of the stock left in the business at the end of the year. It is the amount of stock that is UNSOLD!

COST OF GOODS SOLD IMPORTANT FORMULA OPENING STOCK + PURCHASES The Cost of Goods Sold figure helps us to work out how much money Sidney has made from the buying and selling of stock during the year. IMPORTANT FORMULA OPENING STOCK + PURCHASES - CLOSING STOCK = COST OF GOODS SOLD

Do you think that I made a profit this year? Well we can help Sidney to find out by taking away the Cost of Goods Sold from Sales Revenue. This tells us how much Gross Profit (or loss) was made.

Bob the Blob’s Question Time Can you work out Sidney’s Cost of Goods Sold? What was Sidney’s Gross Profit figure for this year?

Well did you get the right answers? You should have got the following answers: COST OF GOODS SOLD Opening Stock = £1,000 + Purchases = £12,000 - Closing Stock =£2,000 = £11,000 Cost of Goods Sold = £11,000 GROSS PROFIT Sidney had Sales Revenue of £35,000. We take away the Cost of Goods Sold =£11,000 This means £35,000 - £11,000 = £24,000 Gross Profit = £24,000

Bob the Blob’s Question Time Explain TWO ways in which Sidney could have increased his levels of Gross Profit? (Hint. Think about changing his suppliers and maybe changing the prices he charges his customers!) What is the correct formula for calculating Gross Profit Sales revenue – cost of goods sold What is the correct formula for calculating Cost of Goods Sold Opening stock + purchases – closing stock = cost of goods sold

THE PROFIT & LOSS ACCOUNT Ok so what is the Income statement all about? THE PROFIT & LOSS ACCOUNT

Ahh actually sorry Sidney but you do not have £24,000 to spend. Cool I’m rich I’ve got £24,000 of profit to spend! Ahh actually sorry Sidney but you do not have £24,000 to spend. This figure is only your GROSS PROFIT figure....we still need to take away all of Sidney’s expenses.

Can you think of what some of these expenses might be?

Hmm what exactly are expenses? Well expenses are extra costs that you have to pay for things that help you to operate as a business.

I had to pay my electric and gas bills, staff wages, rent for the warehouse and van hire. So you see when we add all of these extra expenses together they suddenly bring down the amount of profit that Sidney earned.

We take away all of the expenses from his Gross Profit to work out his OPERATING PROFIT. OPERATING PROFIT = GROSS PROFIT – TOTAL EXPENSES

Work out Sidney’s Operating Profit using these figures. Electricity Bill = £1,500 Gas Bill = £1,450 Telephone Bill = £325 Petrol for Van = £500 Gross Profit = £24,000 Rent of Warehouse = £5,500

OPERATING PROFIT = £14,725 Did you remember to show ALL of your working out!

Right so I’ve made £14,725. Can I spend all of this? OPERATING PROFIT Unfortunately not Sidney.....you still owe money to the bank and the Government in the form of Taxes!

You always pay the Banks back first! You owe the bank £2,500 in interest payments on your loan. You always pay the Banks back first!

Sole Traders & Partnerships pay Income Tax And you owe the Government £3,000 in tax please! Sole Traders & Partnerships pay Income Tax Companies pay Corporation Tax

Operating Profit = £14725 Interest Charges = £2,500 Tax Bill = £3,000 Can you work out Sidney’s Net Profit using these figures? Operating Profit = £14725 Interest Charges = £2,500 Tax Bill = £3,000 PROFIT =£9,225

What is the name of the tax that Sole Traders and Partnerships must pay upon their profits? Answer: Income tax What is taken away from Operating Profit first: Interest or Taxes? Answer: Interest

Ok I’ve made £9,225 Net Profit can I spend this now? YES!!!! Once you have taken away interest and tax payments, what is left as Profit is entirely your own money to spend as you want to.

I’m going to save £2,000, and take out £7,225 as my wages (called DRAWINGS). When a business saves some money this is called RETAINED PROFIT. This can be used for future investment and means that they will need to borrow LESS from a bank! If Sidney was a limited liability company he might have to pay DIVIDENDS

APPROPRIATION ACCOUNT The Appropriation Account is the final section that we need to learn. This shows us what Sidney decided to do with his £9,225 of Profit.

What does a proper Trading, Profit & Loss Account look like?

Example Business Ltd   Income Statement 20X1 20X0 Year Ended 31 December £'000 Revenue 21,450 19,780 Cost of sales 13,465 12,680 Gross profit 7,985 7,100 Distribution costs 3,210 2,985 Administration expenses 2,180 1,905 Operating profit 2,595 2,210 Finance costs 156 120 Profit before tax 2,439 2,090 Tax expense 746 580 Retained profit 1,693 1,510

Create you own Variable costs per unit= £ 50 Sales volume= 1650 Selling price= £13.50 Wages= £2000 Insurance= £ 387 Rent= £ 2750 Depreciation= £ 450 Advertising= £ 366

Complete Exam question 1 (a-e), pg 293 and Exam Question 2 (a-e) for H/W