Financial Accounts

Financial Statements
To help communicate financial data, the following accounts are prepared:

Trading Account Profit & Loss Account Balance Sheet These accounts provide information relating to an organisations activities during a trading period usually one year.

Trading Account

Trading Account

Compares the value of sales to the customer with the value of the sales at cost price. Difference between the Sales Value (turnover) and the Cost of Sales is the Gross Profit Items that might appear include:

Sales (turnover) Purchases Returns inwards / outwards Stock at start of trading period Stock at end of trading period

This account details any item that relates to the sales or the cost incurred when making those sales

Trading Account Simple Format & Templates Trading Account Questions

Profit & Loss Account

Profit & Loss Account

Used by business as a statement for both internal and external reporting. This calculates the final profit (net profit) or loss that an organisation has made over a financial time period. The Profit & Loss Account is a continuation of the Trading Account it starts with the Gross Profit

Lists any items of additional revenue raised and any expenses incurred not directly linked to trading.

Profit & Loss Account

Items that might appear include: Additional revenue (income)

Discounts received Commission received Rent received Investment income

Expenses not Linked to Trading

Wages Rent Insurance Advertising Depreciation Stationery Any other general expense

Where does a P&L account start? Profit & Loss Account (sole trader)
Profit & Loss Account Questions

Profit & Loss Account

Under the Companies Act 1985, a limited company must produce their year-end accounts in accordance with a legal format.

Trading Profit & Loss Account (Ltd)

Profit & Loss Account

The type of profit and loss account that is produced will depend on the type of business e.g. Sole trader, partnership, private limited company or public limited company

Trading & Profit & Loss Account Terminology

Questions
Distinguish between the following financial terms
1.
2. 3.

4.

Opening stock and closing stock Gross profit and net profit Purchase returns and sales returns Purchases and sales
(4)

Solution

Balance Sheet

Balance Sheet

A balance sheet shows the financial worth and financial position of a business at a particular point in time (usually the last day of the financial year). It is out of date by the time it is published.

Balance Sheet
Shows 3 different things:

Assets (things that the business owns)

Fixed (buildings etc Listed in order of permanence) Current (can easily be turned into cash e.g. stock)

Liabilities (what it owes to others e.g. creditors, bank)

Current liabilities (creditors due within one year) Long term liabilities (creditors due over 1 year)

Capital (money invested in business by owners to set it up)

Balance Sheet
Accounting equation:

CAPITAL = ASSETS - LIABILITIES

Balance Sheet

The Balance Sheet is presented in 2 parts: Top half assets and liabilities Bottom half capital The top half of the balance sheet must equal the total of the bottom half of the balance sheet. Balance Sheet - Sole Trader & Partnership Balance Sheet - Limited Company
Balance Sheet Terminology

Questions
Distinguish between the following financial terms
1. 2. 3.

Fixed Assets and Current Assets Long-term liability and Current Liability Capital and drawings

(3)

Solutions

Question
Describe the purpose of an organisation preparing a profit and loss account and a balance sheet.

(2 marks)
Describe the contents of the following financial statements (identify at least two items that would be shown in each):

a Trading Account a Profit and Loss Account a Balance Sheet

(9 marks)

Solution Q1

An organisation would produce a profit and loss account because its shows the income and costs of the business over a financial period. This enables a business to work out if it has run at a profit or loss. They would prepare a balance sheet because it lists the assets and liabilities of the business, how it is financed and the value of the business at that particular time.

Solution Q2

A trading account shows the sales and cost of sales resulting in the calculation of the gross profit; purchases, opening and closing stocks, sales, sales returns. A profit and loss account shows the net profit or loss after all the expenses have been deducted from the gross profit, and any items of income added on to the gross profit; rent, wages, electricity, commission received. A balance sheet shows the value of an organisation as at a particular date; fixed assets e.g. equipment, vehicles; current assets e.g. stock, debtors, cash; current liabilities e.g. creditors; financed by e.g. capital.

(1 mark for each description, 2 marks for ID)

Interpreting Final Accounts

All public and private companies are required to provide financial statements at end of each trading period. Inland Revenue use information to calculate the tax payable.

Interpreting Final Accounts

Sole Traders / Partnerships / Private Companies

Not legally obliged to make final accounts public. May need to provide them when attempting to borrow from banks etc.

Public Limited Companies

Legally obliged to publish final accounts

Question

Outline the main elements in the final accounts of a business and how each of these elements is calculated (6 marks)

Solution

The trading account shows the gross profit This is achieved by deducting the cost of goods sold from sales revenue The profit and loss account shows how much net profit the business has made This is achieved by deducting expenses from the gross profit The balance sheet shows the financial worth of the organisation. It is calculated by deducting the assets from the liabilities

Interpreting Final Accounts

The following may use the information in published accounts:

Rival companies Investors Lenders Trade Union Representatives Interpreting the data and making comparisons with previous years or other organisations gives an indication of the future success and financial security of an organisation.

Interpreting Final Accounts

Interpretation of Trading Profit & Loss Accounts

Was this years trading result good or bad, compared with last year or with a rival company? Has the Gross Profit improved this year, compared with last year? Are we making efficient use of our stock? Does our Net Profit figure compare favourably with those of other organisations in the same industry?

Interpretation of Balance Sheets

Do we have enough working capital to avoid cash flow problems? Are we making enough use of available trade credit? Is our level of debtors comparable with that of our industry competitors?

Trading Profit & Loss Account Terminology

Trading account Provides a summary of the businesss trading activity during the financial year. Sales Monies that the business has received from selling goods and/or services Turnover/net sales The value of the businesss sales less the value of any returns. Cost of sales Costs associated directly with the production/purchase of goods or services
Balance Sheet

Trading Profit & Loss Account Terminology

Opening stock The value of the stock of goods at the start of the financial period Purchases The cost of goods that the business has bought for resale to its customers. Carriage Inwards The cost of transporting or delivering goods purchased by the business for resale Purchase Returns The value of goods purchased but returned to the supplier e.g. wrong colour, faulty
Balance Sheet

Trading Profit & Loss Account Terminology

Closing stock The value of unsold stock at the end of the financial period Gross profit/loss The profit (or loss) recorded as the difference between the businesss sales and purchases Expenses Any expenses incurred by the business in the course of its normal operation Net profit/loss The profit (or loss) recorded after all business expenses have been deducted
Balance Sheet

Trading Profit & Loss Account Terminology

Corporation tax A tax on business profits payable to the Government Dividend Proportion of the business profit paid to shareholders and dependent on the number of shares that they own. Unappropriated profit Profit retained in the business i.e. not distributed to owners or shareholders.
Balance Sheet

Balance Sheet Terminology Limited company

Fixed asset Something the business owns and depends on to operate on a daily basis. Usually has a degree of permanence e.g. property, equipment, furniture, vehicles Current asset Assets that are likely to be changed into cash in the short term. They frequently change in value e.g. stocks, debtors, cash Current liability Something that the business owes money for in the short term. They must usually be paid within a period of 12 months or one year e.g. creditors, bank overdraft, dividends and taxation Long term liability Debts of the business that are due to be repaid for more than 12 months e.g. debentures, mortgages Interpretation

Balance Sheet Terminology Limited company

Net current assets (Working Capital) The amount by which total value of current assets exceeds the total value of current liabilities. Value of current assets should be greater than value of current liabilities. If not, organisation may be facing serious cash flow problems. Net assets (Capital employed) Net fixed assets + net current assets. Shows the net value of the firm once short-term debts have been repaid. Issued share capital Money put into organisation by the owners or shareholders. In return for their investment they receive dividend payments.

Interpretation

Balance Sheet Terminology Sole trader or partnership

Owners capital at start Value of the owners investment at the start of the accounting period and any retained profits accrued in previous trading periods. Profit The value of net profit taken from the Profit & Loss Account. Owners capital at the end Value of the owners capital at the end of this financial period.
Interpretation

Balance Sheet Terminology Sole trader or partnership

Capital The money invested by the owner(s) of the business to set it up. The money is owed back to the owner(s) by the business. Reserves Profits retained by the organisation after the payments of dividends to shareholders and after provision has been made fore all other current liabilities. Drawings The value of resources that are withdrawn from the organisation by the owner(s) for their private use. Can be taken in form of cash, goods or services. Interpretation