1. BUSINESS ACCOUNTING U23348/U20431/U21076
LECTURE 2
The business cycle, capital and revenue expenditure, calculating profits

2. At the end of this lecture, you should be able to:
Understand the features of a normal business cycle.
Distinguish between capital and revenue expenditure and explain why this is important.
Calculate gross profit margin of a product and a business.
Prepare a simple statement of profit or loss for a small trading business.
Understand the basic difference between cash and the profits of a business.

3. SMART SPORTS EXAMPLE - CASH and PROFITS
CASH is very important for businesses survival, to finance its operations.
In the longer term Sam Smart and others interested in his business need to know if his business is PROFITABLE.
Does the income exceed the expenditure?
Calculating profits correctly is important for a business.
This is not shown on a cash budget and is not the same as the bank (cash) balance of a business at any point in time.

4. SALES and PURCHASES – THE BUSINESS CYCLE (1)
Goods, materials or services must be purchased, usually in exchange for cash.
These can then be sold to customers, perhaps after some conversion or manufacturing cost.
Sales and purchases can be made for cash or on credit (last lecture).
Sales are made when the customer takes delivery.
Purchases are made when the business takes delivery from the supplier.

5. SALES and PURCHASES – THE BUSINESS CYCLE (2)
With credit sales, a trade receivable is created (owed TO business).
With credit purchases, a trade payable is created (owed BY business).
When the customer pays for goods received, the trade receivable disappears – cash/bank increases.
When the business pays the supplier for goods received, the trade payable disappears – cash/bank decreases.
**With the MATCHING CONCEPT expenses are matched to the revenue they have generated, to calculate profit**

6. Conversion, manufacture
THE BUSINESS CYCLE
This is a continuous process!
PURCHASES
Conversion, manufacture
Trade payables
CASH/BANK
Trade receivables
SALES

7. CAPITAL and REVENUE EXPENDITURE/INCOME (important)
Capital expenditure refers to expenditure where the business will benefit for more than one accounting period – (purchase of a delivery van or building).
Revenue expenditure relates to expenditure for day-to-day expenses (purchases, telephone or staff salary costs).
Similarly, capital income will benefit the business for more than one accounting period (owner’s capital and loans), and revenue income is sales and day-to-day income.

8. Capital or revenue expense?
TYPES OF EXPENDITURE
Capital or revenue expense?
Printing machine
Capital
Computer
Purchases of goods for resale
Revenue
Accountant's fees
Electricity
Insurance
Telephone
Drawings
DEDUCT FROM OWNER‘s CAPITAL!
Delivery expenses

9. QUICK QUESTION
In which category – capital or revenue expenditure – do you think the purchase of paper clips would fall? - they often last for more than one year - you keep them and use them in the business
Too small in value to be capital expenditure – treat as stationery expense

10. BASIC PRINCIPLES and TERMS
The statement of profit or loss shows the revenue income less the revenue expenditure for a financial period and calculates the profit or loss generated.
Inventories (stock) are goods for resale held in stock by the business.
Inventories should not be included in working out the cost of goods that have been sold – they are still owned and will be sold later.

11. CALCULATING COST OF SALES
Opening inventories X Add: purchases X X Less: closing inventories (X)
GROSS PROFIT = SALES less COST OF SALES (or COST OF GOODS SOLD)

12. GROSS PROFIT MARGIN Shows direct trading profit, very useful!
GROSS PROFIT = Sales less Cost of Sales
GROSS PROFIT MARGIN = Gross Profit x 100
Sales
If Sam sells hockey kits for £6,000 and they cost him £4,200, gross profit is:
(£6, £4,200) / £6,000 x 100 =
£1,800 / £6,000 x 100 = 30% gross profit margin

13. GROSS PROFIT MARGINS
Different products and services will have different gross profit margins – useful for managers!
These need to be added together to calculate an overall gross profit margin for a business.
If Sam sells football kits for £4,000 and these cost him £2,000, the gross profit on these will be £2,000 OR:
£2,000 / £4,000 x 100 = 50% gross profit margin
Total gross profit will be (£1,800 + £2,000) = £3,800, compared to sales of (£6,000 + £4,000) = £10,000, OR £3,800/£10,000 = 38% overall.

14. SMART SPORTS EXAMPLE – CALCULATING PROFIT
The revenue income and expenditure for Smart Sports is given in the next slide.
From this information, prepare the statement of profit or loss for the year ended 31 December 2015.

15. Value of purchases unsold at the end of the year (inventory) is £2,700
SMART SPORTS – YEAR ENDED 31ST DECEMBER 2015
Revenue income
Sales
51,000
Revenue expenditure
Purchases
34,500
Electricity
1,920
Insurance
1,750
Telephone
1,500
Sundry expenses
1,650
Accountant’s fees
Delivery costs
1,200
Value of purchases unsold at the end of the year (inventory) is £2,700

16. Smart Sports Statement of Profit or Loss for the year ended 31st December 2015
Income
51,000
Less: Cost of Sales
Opening inventory
Purchases
34,500
Less: Closing inventory
(2,700)
31,800
Gross profit
19,200
Less: Expenses
Electricity
1,920
Insurance
1,750
Telephone
1,500
Sundry expenses
1,650
Accountant’s fees
Delivery costs
1,200
9,520
Net profit
9,680
New business so no opening inventory
NET PROFIT = GROSS PROFIT LESS REVENUE EXPENSES

17. DIFFERENCE BETWEEN CASH and PROFITS
Cash is the amount of actual money that a business has (usually in business bank account).
Not all income/expenditure is received/paid for immediately.
Capital expenditure will involve payment of cash but not affect profits.
Capital put into a business by an owner will increase cash but not affect profits.
Drawings taken from a business by an owner will decrease cash but not affect profits.

18. ** SUMMARY OF KEY POINTS **
Transactions are accounted for in the period in which they occur – matching concept.
In the statement of profit or loss, revenue income is compared with revenue expenditure.
Cost of sales (or cost of goods sold) takes into account opening and closing inventories.
Gross profit equals sales less cost of sales.
Net profit equals gross profit less all other revenue expenses.
Cash and profit are not the same.