Trading, Profit & Loss Account
This shows a business's financial performance over a given time period e.g. one year.
Sample trading, profit and loss accountSales revenue £80,000 Less costs of sales £50,000 Gross profit £30,000 Less other expenses £20,000 Net profit £10,000
The trading account shows the business has made a gross profit of £30,000 before taking into account other expenses such as overheads.
The profit and loss account shows a net profit of £10,000 has been made.
Components of financial statements
- Revunue: Income received by a business from selling its goods/services over the period covered by the profit and loss account.
- Cost of Sales: the costs involved in directly supplying goods or services e.g. the wages, raw materials, energy- gas.
- Gross Profit: Revenue - cost of sales.
- Overheads/Expenses: Costs that don't alter when the level of production changes e.g. salaries of managers, insurance costs, interest costs, maintenence.
- Net Profit: Calculation by taking overheads away from gross profit figure. Used as good measure of performance.
Why do businesses prepare financial statements?
- Legal requirents the Companies Act
Business may be fined, forced to cease trading if they have not prepared an account. Sole Traders and partnerships don't have to follow the same legal rules.
- To help the business's managers
Accounts are very helpful, the help to make decisions in improving performance (e.g. profits were low, managers will take action to change this).
- To guide investors
Gain a lot of information, if you are interested in investing then you can judge how safe an investment is, deciding whether or not the investment will earn a profit.
A balance sheet shows the value of a business on a particular date. A balance sheet shows what the business owns and owes (its assets and its liabilities).
Fixed assets £150,000 Current assets £25,000 Current liabilities £100,000 Net assets employed £75,000 Capital and reserves £75,000
This balance sheet shows that the business has total assets of £175,000, owning £150,000 in fixed assets and £25,000 of cash or near-cash available to the firm. Then by taking away the liabilities, which are the things that the business owes to other businesses or individuals, this gives the value of this business on this day, £75,000.
Fixed assets - you keep this type of asset long term, e.g. shops, vehicles - create revenues & enable it to earn profits.
Current assets - short term (less than 1 year), cash, stocks of raw materials, used to settle debts (pay for raw materials).
Total equity - Part of company that belongs to shareholders (value of ownership). if the business stops trading it can sell its fixed and current assets, they usually have to pay its liabilities (debts).
A business is solvent if it can meet its short-term debts when they are due for payment. To do this it needs adequate working capital. There are three main reasons why a business needs adequate working capital. It must:
- Pay staff wages and salaries.
- Settle debts and therefore avoid legal action by creditors.
- Benefit from cash discounts offered in return for prompt payment.
You can work out a firm's working capital with:
Working Capital = Current assets - Current liabilities.
Many groups of people are interested in the published accounts of a company. The information they provide may influence future decisions. For example, lenders will be looking at the solvency of a business. Rivals are interested in monitoring the profits earned by competitors.