3. Finance
3.2 Profit and Loss Accounts and
Balance Sheets
3.2 Profit and Loss Accounts and Balance Sheets
IF I BORROW A MILLION POUNDS AM I A MILLIONAIRE?
Revisiting unit 1
3.2 Profit and Loss Accounts and Balance Sheets
• In unit 1 you looked at some basic financial terms and
calculations – can you remember these?
• Roger sells 2000 pairs of jeans at £35 per pair
▫ What is his sales revenue?
• He buys each pair of jeans from a wholesaler for
£15
▫ What are his variable costs?
▫ How much profit does he have so far?
• In addition he has to pay overheads of £10000
▫ How much profit does he have left now?
In unit 2 you are going to look at how a business presents this and other
information in its accounts.
3.2 Profit and Loss Accounts and Balance Sheets
3.2 Profit and Loss Accounts and
Balance Sheets
• In this topic you will learn about:
▫ Purpose of financial statements
▫ Components of financial statements
▫ Interpretation of data given on financial
statements
3.2 Profit and Loss Accounts and Balance Sheets
What are financial statements?
• A business has to record all transactions of money
going into and out of the business
• These transactions form a numerical history of the
business and are summarised in the financial
statements
• These statements show whether the business has
made a profit or a loss and how much it is worth
• The two financial statements you will look at here
are
▫ Profit and Loss Account
▫ Balance Sheet
3.2 Profit and Loss Accounts and Balance Sheets
Purpose of financial statements
• Keeps the business and other stakeholders
informed about the businesses performance
▫ Identifies whether the business is making a profit or a
loss
▫ Shows how much the business is worth
• Tracks the flow of cash into and out of the business
• Informs managers on the payment of suppliers and
receipts from customers
• Helps inform future decisions
3.2 Profit and Loss Accounts and Balance Sheets
Different stakeholders will want to view financial
statements for varying reasons
• In pairs think about why each group of stakeholders might be interested
in the financial statements of a business
Stakeholder Group
Shareholders
Employees
Suppliers
Customers
Bank
Government
Reason for Interest
Profit and Loss Account
3.2 Profit and Loss Accounts and Balance Sheets
• Shows a summary of a firm’s trading and expenses in a
given time period (normally a year) in order to identify
whether the firm has made a profit or a loss
• The components are:
▫ Sales Revenue
 The total amount of money achieved as a result of selling goods or
services
▫ Cost of Sales
 The costs which are directly related to producing the goods or
services sold e.g. Raw materials
▫ Gross Profit
 Sales Revenue minus Cost of Sales
▫ Expenses
 All other costs experienced by the firm, also called overheads
▫ Net Profit
 Gross Profit minus Expenses
Profit and Loss Account
3.2 Profit and Loss Accounts and Balance Sheets
A sample Profit and Loss Account for Nuts and
Bolts Ltd
£ms
Sales Revenue
650
Cost of Sales
325
Gross Profit
325
Expenses
247
Net Profit
78
3.2 Profit and Loss Accounts and Balance Sheets
Interpretation of a P&L a/c
▫ To interpret accounts we use simple ratios; this
means comparing one figure to another
 What is the ratio of students to teacher in your class?
 What is the ratio of empty seats to full seats?
 What would each of these answers be expressed as a
percentage?
▫ In accounts there are two ratios used here to
interpret a P&L a/c
 Gross profit margin
 Shows gross profit as a percentage of sales revenue
 Net profit margin
 Shows net profit as a percentage of sales revenue
Interpretation of a P&L a/c
3.2 Profit and Loss Accounts and Balance Sheets
Gross Profit Margin
Net Profit Margin
Gross Profit x 100
Sales Revenue
Net Profit x 100
Sales Revenue
Nuts and Bolts Ltd
Nuts and Bolts Ltd
£325m x 100 = 50%
£650m
£78m x 100 = 12%
£650m
What does this mean?
For every £1 made in sales 50p is
left as gross profit
A very low gross profit margin
may indicate that the cost of sales
is too high in relation to selling
price
What does this mean?
For every £1 made in sales 12p is
left as net profit
A very low net profit margin
may indicate that the cost of
sales and or expenses are too
high in relation to selling price
Profit and Loss Account
3.2 Profit and Loss Accounts and Balance Sheets
▫ Rearrange the information below to produce a
completed Profit and Loss account for Charlie Fashion
Ltd (neither the numbers or headings are in the correct
order)
▫ Gross Profit = £27m
▫ Net Profit = £4.5m
Expenses
Sales
revenue
Gross profit
Net profit
Cost of sales
£27m
£63m
£4.5m
£90m
£22.5m
£ms
Calculate the
Gross Profit Margin
(Gross Profit/ Sales Revenue x 100)
and Net Profit Margin
(Net Profit/Sales Revenue x 100)
for Charlie Fashion Ltd
Profit and Loss Account
3.2 Profit and Loss Accounts and Balance Sheets
The directors of Charlie Fashion Ltd are concerned about how
the business is performing. The following data has been taken
from the last 2 years company accounts.
2010
2011
Sales Revenue
£90m
£83m
Gross Profit
£27m (GPM 30%)
£25.5m
Net Profit
£4.5m (NPM 5%)
£5.1m
Question Time
1.
2.
3.
Calculate the percentage change in sales revenue between 2010
and 2011.
(2 marks)
Calculate the Gross and Net Profit Margins for 2011. Show your
workings.
(4 marks)
To what extent do you think that the directors are right to be
concerned about the financial performance of Charlie Fashion
Ltd?
(9 marks)
Balance Sheet
3.2 Profit and Loss Accounts and Balance Sheets
• Shows a summary of everything a business owns (its
assets) and what it owes (its liabilities) in order to
calculate the net worth of the business at a set point
in time
• The components are: (Part 1)
▫ Fixed Assets
 Items owned by the business that it will keep for more than
one year e.g. Premises
▫ Current Assets
 Items owned by the business that are to be sold or used
within one year e.g. stock
▫ Current Liabilities
 Items the business owes that are to be paid back within one
year e.g. An overdraft
▫ Long term liabilities
 Items the business owes that are to be paid back in over
one year e.g. Bank loan
Balance Sheet
3.2 Profit and Loss Accounts and Balance Sheets
• Part 1 of the balance sheet shows where money is tied
up in the business in assets, and where it is owed in
liabilities.
• The liabilities are deducted from the assets to give the
Net Assets
▫ This figure indicates the worth of the business
• But where did the money come from to create this
worth? This is shown in part 2
• The components are: (Part 2) Capital and Reserves
▫ Shares Issued
 Capital raised by the sale of shares
▫ Retained Profit
 Profit kept by the business
A Sample Balance Sheet for Nuts and Bolts Ltd
Fixed Assets
Premises
Equipment
Machinery
Vehicles
Current Assets
Stock
Debtors
Cash
Current Liabilities
Creditors
Overdraft
Net Current Assets
Total Assets less Current Liabilities
Long Term Liabilities
Bank Loan
Net Assets
Capital and Reserves
Shares Issued
Retained profit
3.2 Profit and Loss Accounts and Balance Sheets
£ms
15
130
200
55
400
174
109
17
300
145
55
200
100
500
(95)
405
125
280
CA – CL
FA+CA-CL
TA – CL- LTL
405
3.2 Profit and Loss Accounts and Balance Sheets
Interpretation of a Balance Sheet
▫ To interpret accounts we use simple ratios; this
means comparing one figure to another
 Here we compare Current Assets to Current Liabilities
 This measures the liquidity of the business i.e. Its ability
to meet day to day expenditure
 Does it have enough money to pay the bills?
▫ In accounts there are two ratios used here to measure
liquidity
 Current ratio
 Expresses current assets in relation to current liabilities
 Acid Test
 A tougher measure that expresses current assets, excluding
stock, in relation to current liabilities
3.2 Profit and Loss Accounts and Balance Sheets
Interpretation of a Balance Sheet
Current Ratio
Acid Test
Current Assets
Current Liabilities
Debtors + Cash
Current Liabilities
Nuts and Bolts Ltd
Nuts and Bolts Ltd
£300m x = 1.5
£200m
£109m+ £17m = 0.63
£200m
What does this mean?
For every £1 in liabilities, short
term debts, the firm has £1.50
with which to pay them from
current assets
Liquidity is healthy
What does this mean?
For every £1 in liabilities, short
term debts, the firm has only
£0.63 with which to pay them
from current assets, excluding
stock
Liquidity is a concern
Balance Sheet
• Replace each letter a - g with the correct figure
Fixed Assets
£ms
Fixed Assets
62
62
Current Assets
Stock
20
Debtors
a
Cash
9
44
Current Liabilities
Creditors
35
Overdraft
5
b
Net Current Assets
c
Total Assets less Current Liabilities
d
Long Term Liabilities
Bank Loan
(4)
Net Assets
e
Capital and Reserves
Shares Issued
26
Retained profit
f
g
▫ Calculate the current ratio and acid test
3.2 Profit and Loss Accounts and Balance Sheets
Balance Sheet
3.2 Profit and Loss Accounts and Balance Sheets
The directors of Charlie Fashion Ltd are concerned about the
liquidity of the business. In 2010 the current ratio was 1.1 and the
acid test 0.6. The following data has been taken from the last 2 years
company accounts.
2011
2010
Stock
£25m
£20m
Debtors
£28m
£15m
Cash
£7m
£9m
Current Liabilities
£50m
£40m
Question Time
1.
2.
3.
What is meant by the term ‘liquidity’?
(2 marks)
Calculate the Current Ratio and Acid Test for 2011. Show your workings.
(4 marks)
To what extent do you think that the directors are right to be concerned
about the liquidity of Charlie Fashion Ltd?
(9 marks)
30 Second Challenge
How many items on
a balance sheet can
you name?
Starting NOW
End
3.2 Profit and Loss Accounts and Balance Sheets
True or False?
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•
•
•
•
•
•
•
•
•
Net profit is higher than gross profit
Gross profit is sales revenue minus cost of sales
Overdrafts appear on a P&L a/c
Current assets are always higher than current
liabilities
Debtors are a current asset
Stock is a current liability
The acid test is lower than the current ratio
Premises are a fixed asset
Bank loans are a current liability
Net profit margin is sales revenue/net profit x 100
5 Minute Test
•
•
•
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•
Name 2 financial statements
What is an asset?
What is a liability?
Name 2 fixed assets
What is a debtor?
What is the difference between a current liability
and a long term liability?
• What are the 5 components of a P&L a/c, in
order?
End