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Business Finance Trading, Profit and Loss Account Text Book
What is Profit?
As it's simplest, profit is what remains from revenue once costs have been deducted. However in the
construction of the profit and loss account there are two main types of profit identified.
1. Gross profit. This form of profit is calculated by deducting direct costs (such as materials and
shop floor labour) from a business's sales revenue. This gives a broad indication of the financial
performance of the business without taking into account other costs such as overheads.
2. Net Profit. This is a further refinement of the concept of profit and is revenue less direct costs
and indirect costs or overheads such as rent and rates as well as interest payments and
depreciation. This is a better indication of the performance of a business over a period of time as
it takes into account all costs incurred by a firm over a trading period. Net profit can take a number
Trading or operating profit. This type of profit takes into account all earnings from
regular trading activities and all the costs associated with those activities. However
this form of profit excludes any income received from, or cost incurred by, activities
that are unlikely to be repeated in the future financial years.
Net profit before tax is a businesses trading or operating profit plus any profits from
one off activities.
Net profit after tax is the amount left to the business once cooperation tax (or income
tin the case of a sole trader or partnership) has been deducted. There are no more
charges on this profit and the managers of the business can decide what to do with it.
Retained profit is the profit that the managers decide to keep within the business. It is
the profit after tax less any dividends paid to shareholders of a company. Retained
profit is used to provide capital for the business and it's often used to purchase
further fixed assets.
Quality of Profit
Firms regard a profit that is likely to continue in the future as a high quality profit. Thus if a business
introduces a new product into the market and it immediately starts to generate a surplus and looks to
have a promising future, then this will be a high quality profit. A low quality profit will not continue in the
The amount of trading or operating profit earned by a firm is more likely to represent highquality
profit as it excludes any one off items. This level of profit might reasonably be expected to continue
into the future, depending upon market conditions. Shareholders are interested in profit quality as it
gives some indication of the company's potential to pay dividends in the future.
Structure of the Profit and Loss Account
The profit and loss account is divided into three sections:
1. The trading account calculates the businesses gross profit
2. The profit and loss account sets out other costs and the one off revenues to provide net
profit after tax
3. The appropriation account records the uses of net profit after tax
The overall profit and loss account details a businesses income (or turnover) and all of its costs for a
period of time, normally one year. This is a major distinction between the balance sheet and the profit
and loss account the former is a snapshot at a particular point in time, whereas the latter relates to a
trading period, normally one year.
This section of the profit and loss account states the income earned by a business over the trading
period. Immediately following is recorded the direct costs associated with this trading activity the
cost of sales. By deducting the costs of sales from the sales income or turnover of the business, we
arrive at a gross profit.
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The sales revenue figure should only include sales once the goods are delivered to the customer.
Goods that a produced but not sold (perhaps because they are added to stock) should only be a part
of sales revenue when a customer receives them. This may occur in a different trading period. The
figure for sales revenue (or sales income or sales turnover) may be subject to a number of
adjustments before the final figure is calculated.
Taxes on spending, e.g.…read more
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The addition of nonoperating income provides the net profit before tax for a company. This figure is
frequently referred to as simply `net profit'. The Inland Revenue uses this figure as a basis for its
computation of the tax liability of the company. All companies earning a certain level of profits are
liable for cooperation tax, which is deducted from the net profit before taxation to give us the net profit
after taxation.…read more
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Sole traders are businesses owned by a single person. The profit and loss account for a sole trader is
very similar to those of companies. Two principle differences exist:
Sole traders are normally give more information on the businesses expenses. This is
possible due to the business's financial affaires being less complex and assist in
managing the business from year to year.
Sole traders do not have an appropriation account as all the profits belong to the single
owner of the business.…read more
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Profit & Loss Accounts Class Notes
The profit and loss account shows where the business has made money e.g. sales (revenue),
Grants / subsidies, selling assets, shares & dividend payments.…read more