02 constructing financial statements

The Trading Profit and Loss Account
Account
Businesses usually calculate their profit level by
creating a Trading Profit and Loss Account (TPL)
The TPL is produced because:
It is a legal requirement
It summarises all the year’s transactions
It shows the financial ‘health’ of the business.
Can be used to compare trade this year with trade last year

© Business Studies Online: Slide 1

The Parts of A T,P&L Account
Account
The document is made up of 3 sections which must be
completed in turn:
The Trading Account
The Trading Account
This calculates gross
This calculates gross
profit. It takes the
profit. It takes the
direct costs of
direct costs of
production away from
production away from
the sales revenue
the sales revenue

The Profit & Loss
The Profit & Loss
Account
Account
This takes the
This takes the
expenses (indirect
expenses (indirect
costs) away from the
costs) away from the
gross profit to
gross profit to
calculate net profit
calculate net profit

The Appropriation
The Appropriation
Account
Account
This shows what will
This shows what will
happen to any profit
happen to any profit
that has been made. It
that has been made. It
usually refers to
usually refers to
dividends and taxation
dividends and taxation

The Structure of a TP&L Account (1)
(1)
Need to calculate
how much it has
cost to make the
goods that have
been sold

Trading Profit and Loss Statement
For Lou Pole, year ending 31.08.04
£
£
Value of stock Sales
400,000
owned at the
start of the year LESS Cost of sales
Opening Stock
100
Value of raw
Purchases
100,000
materials
100,100
purchased
during the year
Less Closing Stock
100
Value of stock
left at the end
of the year.
This will be
next year‛s
OPENING
STOCK

Business
Name and
Date

Sales, the
money from
selling goods

100,000
Gross profit

300,000
Calculated by
subtracting
cost of sales
from sales


The Structure of a TP&L Account (2)
Expenses
listed and
a total
given

£
Gross profit
LESS Expenses
Salaries
Rent
Other
Total expenses
Net profit
Corporation Tax
Profit after tax
Dividends
Retained profit

Calculated by subtracting dividends.
This is the amount of money that will be
kept in the business

75,000
25,000
14,000
114,000

£
300,000
Calculated by
subtracting
expenses from
Gross Profit

186,000
74,400
111,600
5,580
106,020

Calculated
by
subtracting
tax from
net profit


Different Types of T,P & L Accounts
Accounts
The T,P & L Accounts of businesses will differ according
to their legal structure
Companies (Ltds & Plcs) are subject to more legal
constraints:
The Accounts Of Incorporated Businesses

Accounts must be published
Accounts usually show figures for 2
years
They must show how the profit is being
used (Appropriation Account)


The Limitations Of T,P & L
L
The trading, profit & loss account
is a historical view of the business
It does not tell us what will happen
in the future – although it may help
to identify trends
Businesses may “manipulate”
accounts in order to reduce their
tax liabilities, or to deter a potential
takeover


Working Capital
Capital
Working capital refers to the materials that a business
needs in order to make the products that it sells
Without working capital a business would be unable to
operate
It is the working capital that produces profit and as such
it is referred to as an investment
However, working capital items are NOT intended to be
kept by the business


How Money Works In Business
Business
Money constantly goes round a business in a cycle
This can be shown as follows:


The Speed of the Working Capital Cycle
Cycle
If the amount of cash at the end of the cycle is bigger
than that at the start then a firm will make a profit
How much profit depends upon how quickly they can
get round this cycle.
How quickly it can get round depends on two factors:
Speed of The
Working Capital Cycle

Creditors
• People a business owes money to.
• They speed up the cycle

Debtors
• People who owe the business money.
• They slow down the cycle.


Calculating the Working Capital
The working capital of a firm is calculated as follows:
Working Capital = Current Assets – Current Liabilities
Where:
Current Assets =
Anything a business owns, which it intends to sell
Examples include raw materials, stock, debtors and cash.

Current Liabilities =
Anything that a business owes, which must be paid within the
next 12 months
Examples include creditors, overdraft and dividends.

This calculation is part of the BALANCE SHEET

What is a Balance Sheet?
Sheet?
A Balance Sheet is a financial statement which
shows the ASSETS, LIABILITIES and CAPITAL of a
business on a particular date
Assets
Assets

Capital
Capital

Are items owned
Are items owned
by the business or
by the business or
owed to the
owed to the
business
business

Is the money
Is the money
invested by the
invested by the
owners or
owners or
shareholders
shareholders

Liabilities
Liabilities
Are amounts owed
Are amounts owed
by the business
by the business


The Key Principle of a Balance Sheet
Sheet
Businesses can only spend money that they either
have, or have borrowed then:
All Assets

must equal

All Liabilities


The Structure of a Balance Sheet (1)
(1)
Business
Name and
Date

Balance Sheet
For A.B.Hive LTD as at 31 December 2004

Fixed assets
Building
Equipment

£
Fixed Assets
are listed and
then added up.

Current assets
Stock
Debtors
Cash at bank

30,000
10,000
5,000
45,000

£
170,000
60,000
230,000
Current Assets
are listed and
totalled


(2)
Current Liabilities
listed and totalled

Current liabilities
Trade creditors

£

Calculated by
£

current assets –
current liabilities

25,000

Net Current Assets
20,000
OR Working Capital
Less Long Term Liabilities
Mortgage
45,000
Loan
5,000
50,000
Net Assets

Calculated by fixed
assets + working
capital – long term
liabilities

Long Term
liabilities
are listed
and
totalled,
then taken
away

200,000

(3)
FINANCED BY:

This section shows
where the money in the
business has come
from.

£

Capital and reserves
Share capital
Profit and loss account

75,000
125,000

Total Capital Employed

200,000
This means that
£200,000 has been
invested in the business


Who Uses A Balance Sheet?
Both the balance sheet and the profit and loss
account show the ‘health’ of the business
All the stakeholders will be interested in the balance
sheet, but especially:
Shareholders
Customers
Suppliers
Employees

When used with the Trading Profit and Loss account
it shows how well the business is doing


The Limitations Of The Balance Sheet
Sheet
As soon as it is produced it is out of date
Fixed assets may be overvalued if they
are depreciated incorrectly
Businesses are not required to include
“intangible assets” such as brand
names. This can understate the value of
the company
Companies tend not to give a
breakdown of the figures – they just
quote totals


Differences In Accounts
Accounts
Different types of business produce different types of
accounts, due to legal requirements:
Unincorporated
Businesses
Must produce
accounts for
taxation purposes

Incorporated
Businesses
Must publish
accounts

Are usually in a
simple format

Often abbreviated
so competitors get
limited
information

T, P & L A/C will
not have an
Appropriation
Account

Usually show 2
years figures
Some terminology
is changed

Share Capital Vs Loan Capital
Capital
There is a big difference between share capital and
loan capital:
Share Capital

Loan Capital

The total amount
invested in a business
by shareholders
Note that share capital
is NOT the same as
Shareholders funds

Is medium – longterm
finance provided by:
Banks
Debentures
Other lenders


Share Capital Vs Shareholders Funds
Funds
Any profits invested in a business belong to it’s
shareholders
As such Shareholders funds can be calculated as:
Shareholders Funds = Share Capital + Reserves


02 constructing financial statements

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