3. Finance

1. 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?

2. 3.2 Profit and Loss Accounts and Balance Sheets Revisiting unit 1 • 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. 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

4. 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

5. 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

6. 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

7. 3.2 Profit and Loss Accounts and Balance Sheets Profit and Loss Account • 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

8. 3.2 Profit and Loss Accounts and Balance Sheets Profit and Loss Account 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

9. 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

10. 3.2 Profit and Loss Accounts and Balance Sheets Interpretation of a P&L a/c Gross Profit Margin Net Profit Margin Gross Profit x 100 Sales Revenue Nuts and Bolts Ltd £325m x 100 = 50% £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 Net Profit x 100 Sales Revenue Nuts and Bolts Ltd £78m x 100 = 12% £650m 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

11. 3.2 Profit and Loss Accounts and Balance Sheets Profit and Loss Account • 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 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

12. 3.2 Profit and Loss Accounts and Balance Sheets Profit and Loss Account 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. Question Time • 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)

13. 3.2 Profit and Loss Accounts and Balance Sheets Balance Sheet • 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

14. 3.2 Profit and Loss Accounts and Balance Sheets Balance Sheet • 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

15. 3.2 Profit and Loss Accounts and Balance Sheets A Sample Balance Sheet for Nuts and Bolts Ltd Fixed Assets£ms Premises 15 Equipment 130 Machinery 200 Vehicles 55 400 Current Assets Stock 174 Debtors 109 Cash 17 300 Current Liabilities Creditors 145 Overdraft 55 200 Net Current Assets 100 CA – CL Total Assets less Current Liabilities 500 FA+CA-CL Long Term Liabilities Bank Loan (95) Net Assets 405TA – CL- LTL Capital and Reserves Shares Issued 125 Retained profit 280 405

16. 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

17. 3.2 Profit and Loss Accounts and Balance Sheets Interpretation of a Balance Sheet Current Ratio Acid Test Current Assets Current Liabilities Nuts and Bolts Ltd £300m x = 1.5 £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 Debtors + Cash Current Liabilities Nuts and Bolts Ltd £109m+ £17m = 0.63 £200m 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

18. 3.2 Profit and Loss Accounts and Balance Sheets 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

19. 3.2 Profit and Loss Accounts and Balance Sheets Balance Sheet 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. Question Time • 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)

20. 30 Second Challenge How many items on a balance sheet can you name? Starting NOW End

21. 3.2 Profit and Loss Accounts and Balance Sheets True or False? • 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

22. 5 Minute Test • 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