Profit and loss accounts and balance sheets

Question 1

What is the purpose of financial statements?

Answer 1

Every business has to keep financial records so that they know:

• Whether a profit or loss is being made
• How much cash is flowing into and out of the business
• When suppliers must be paid for goods and when tax must be paid to government

Question 2

What will a financial statement include?

Answer 2

• Products sold; the value of them and which customers have not yet paid
• Goods and services brought by the business; the value of them and which suppliers have not yet been paid
• Equipment and other assets purchased
• Wages and other labor costs

Question 3

What is profit?

Answer 3

• Profit is the RETURN for taking a RISK
• Profit measures the success of an INVESTMENT
• Profit is an important SOURCE OF FINANCE

Question 4

What is the formula for profit?

Answer 4

Profit = total sales - total costs

Question 5

What is profit in absolute terms?

Answer 5

The value (£) of profits earned 
E.g. £50,000 profit made in the year

Question 6

What is profit in relative terms?

Answer 6

The profit earned as a proportion of sales achieved or investment made

• E.g. £50,000 profit from £500,000 profit of sales is a profit margin of 10%
• E.g. £50,000 profit from an investment of £1 million = 5% return on investment

Question 7

What is a profit and loss account?

Answer 7

A historical record of the trading of a business over a specific period (normally one year)
Shows the profit or loss made by the business- - which is the difference between the firm’s total income and its total costs

Question 8

What are the five important pieces of information on a profit and loss account?

Answer 8

1) The sales revenue: goods sold X price
2) Cost of sales: the cost of the goods + labour costs
3) Gross profits: sales revenue - cost of sales
4) Overheads: expenses of the business that are not part of production (e.g. rent and management salaries)
5) Net profit: also known as operating profit. Profit after all costs. Gross profit - overheads

Question 9

Interpreting profit and loss accounts

Answer 9

• To properly understand what the numbers mean on a PL&L we need to have something to compare them with
• This could be numbers from previous years to see if the firm is doing better or worse
• It could also be compared with the colse comp