Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.) Module 5: Profit and Loss Statement Profit and Loss Statement Goal Purpose Concept (introduction...) Goods Sold Expenses Basic Formula An Example of a Profit and Loss Statement Introduction Value of Stock Depreciation Cash book Calculation Appendix A: Exercise in Profit and Loss Statement (introduction...) 1. Value of Stock 2. Depreciation of Equipment and Workshop 3. Cash Transactions 4. Profit and Loss Statement 5. Answers to the Exercises a. Stock Record b. Depreciation c. Cash Book d. Profit and Loss Statement Appendix B: The Difference between Cash and Profit 1. The Question 2. Where the Difference Comes From 3. Example

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.)

Module 5: Profit and Loss Statement

Profit and Loss Statement

Goal

This module explains, what a profit and loss statement is used for and how it is made.

Purpose

As long as there is some cash, a business will live. But after a certain time of loss, the business will cease to exist, because all the money will be used up. Please keep in mind:

1. Cash and profit are not the same thing. 2. There is no direct relationship between cash and profit.

Therefore, it is not enough to control the cash of your business, you need to know, whether your business is making a profit or not.

The cash book tells you, how much cash you have in your cash box. The profit and loss statement is used to determine how much profit (or loss) your business has made. If you have a cash book and a profit and loss statement you can clearly see how much of your cash really is profit (see Appendix B for further information).

Concept

The following formula shows the basic structure and components of the profit and loss statement:

Sales
	- Costs of Goods Sold
	= Gross Profit (or Loss)
	- Expenses
	= Net Profit (or Loss)
	- Withdrawals
	= Retained Profit (or Loss)

There are three different types of profit: gross profit, net profit, and retained profit. For the business person net profit is important because it shows how much can be withdrawn from the business. For the business the retained profit is important because it shows how much of the profit is available to expand the business after the owner or partners have withdrawn their share.

Goods Sold

The costs of goods sold means the total cost of all materials which make part of the products sold during a given period. Therefore costs of goods sold might be costs of all raw materials.

If you only do one profit and loss statement per year and do not need exact figures, this definition will do. Normally, however, the profit and loss statement is done every one to three months. Within this period the amount of raw materials bought does not correspond exactly to the amount of raw materials used. For example, the cement bought in one month may be sufficient for the following three months. The costs of goods sold would be high in one month and low in the next months, even though the same amount of raw materials was used every month. This effect distorts the result of the profit and loss statement. For that reason, changes in stock should be taken into account:

If the stocks of raw materials are reduced in one period, this is considered to be costs.

The following formula shows how to calculate a more accurate costs of goods sold:

Raw Materials at the Beginning
	+ Raw Materials Purchased During the Period
	= Raw Materials Available for Production
	- Raw Materials Remaining at the End of the Period
	= Costs of Goods Sold

Expenses

All the other costs of production are called expenses. They include:

· Wages and salaries,
· Social security expenses,
· Water and energy,
· Transports,
· Marketing,
· Maintenance,
· Rent,
· Depreciation,
· Taxes and fees,
· Interest on loans.

Attention The following two points are very important and must not be forgotten: · Money spent on investments is not an expense, but depreciation is. · Loan repayments are not expenses, but loan interest is. Investments and loan repayments are normally irregular and large. They would distort the result of the profit and loss statement. For that reason, depreciation and loan interest are used in the profit and loss statement.

Basic Formula

The basic formula needed to calculate profit and loss is:

+ Total sales
	+ Final value of stock
	- Initial value of stock
	- Purchase of raw materials
= Gross profit
	- Working costs (wages, salaries and social expenses)
	- Production inputs (water, energy, consumables)
	- Overheads (transports, office, marketing, maintenance, taxes and fees, interests)
	- Depreciation (buildings and equipment)
= Net profit (or loss)
	- Withdrawals
= Retained profit (or loss)

An Example of a Profit and Loss Statement

Introduction

A profit and loss statement should be prepared monthly, quarterly or annually. The information shown in the profit and loss statement is obtained from three sources:

· The Stock Record format gives the data for initial and final value of stock.
· The depreciation figures are found in the Depreciation Summary.
· All the other figures are found in the Cash Book.

These three sources are illustrated below.

Value of Stock

The value of stock is taken from the stock record.

Figure

The following points are important:

· The value of stock has to be determined at the beginning and at the end of each accounting period. Normally, the beginning of one period is the same as the end of the previous period.

In Mr. Garcia’s Stock record from the 31st of March shown above, the “total value of stock” is the final value of stock on 31.3.92 (at the end of the First Quarter of 1992). Therefore, the same amount will be the initial value of stock on 1.4.92 (at the start of the Second Quarter of 1992).

· Make sure that the value is based on the actual costs for raw materials as well as for final products. To determine the “costs/unit” of the raw materials, consult the invoices of the most recent deliveries. The costs per piece of final product has to be calculated as shown in Module 4, “Costing and Pricing”.

Depreciation

The method for calculating the depreciation of buildings and equipment is described in the Module 4, “Costing and Pricing”. The amount shown in the profit and loss statement is based on the total in the “Depreciation Summary”:

Figure

Attention The Depreciation Summary shows the depreciation as calculated per year. Remember, all calculations must be for the same period. If the profit and loss statement is made for three months, the amount of depreciation is only one forth of the total amount of the yearly depreciation shown in the Depreciation Summary.

Cash book

The cash book is already known from Module 3, “Cash Management”:

Figure

Calculation

The profit and loss statement is now made as follows (for an example see next page):

Step 1

Decide on the time period, for which you need to make the profit and loss statement. If there is no inflation and your business is doing well, once per year is enough. If you have a lot of changes in quantities, costs and prices or if you frequently have a lack of cash, then the profit and loss statement should be prepared monthly or quarterly.

Mr. Garcia decides to prepare a profit and loss statement quarterly.

Step 2

Determine the value of stock at the beginning and at the end of the period. Fill in the figures in the profit and loss statement.

Above, you can see the format, Mr. Garcia filled in on the 31st of March. The stock has a value of LU 55’300. On the 30th of June, Mr. Garcia determines once more the value of his stock and finds out that it is LU 71’900.

Step 3

The “Depreciation Summary” may help to determine the depreciation. Determine the depreciation for the time period and, if necessary, calculate it in LU. Then fill the figure in the profit and loss statement.

Mr. Garcia has to depreciate $ 1’000 per year. Per quarter of a year, he has to depreciate one forth, that is $ 250. By the end of June 1992, the exchange rate is 100. That means, for one dollar, LU 100 has to be paid. Therefore, the $ 250 are the same as LU 25’000.

Step 4

Now take the cash book. Within the calculation period of the statement, all cash transactions with a certain code are added up and the result is entered into the corresponding field of the statement. This is done with all the codes of the statement.

Mr. Garcia takes the cash book and starts with the first code 100 for sales. He finds three entries corresponding to that code: Tiles for Mr. Brown at the 5th of April, Tiles for Mr. Grey on the 21th of April and tiles for Housing and Co. on the 3rd Of June. The total amount of sold tiles is 110’000 + 120’000 + 150’000 = LU 380’000. He enters the figure into the profit and loss statement. Then he takes the next code, 200, raw materials, and again finds three entries in the cash book. He adds up the entries and enters the total (LU 123’000) into the profit and loss statement. He does so with all other codes. Only two entries of the cash book are not taken into account: The investments (new moulds on the 19th of May) and the pay back of loans (on the 18th of June). The net profit is LU 127’600. Mr. Garcia decides to withdraw LU 20’000. The retained profit therefore is LU 107’600.

The corresponding profit and loss statement looks now as follows:

Figure

Attention Not all of the figures from the cash book are used for the profit and loss statement. The following cash transactions are not used to calculate profit and loss: · Investments (for example, “New Moulds”.), · Loan Repayments.

How to analyse the result of the profit and loss statement is explained in the next module (module 6: “Financial Analysis”).

Appendix A is an exercise for your practice.

Appendix A: Exercise in Profit and Loss Statement

Mr. Garcia decides on preparing a profit and loss statement for the first quarter of 1992. For that reason he is looking for the figures needed to do so:

1. Value of Stock

On the 1^st of January Mr. Garcia counts his stocks. He has the following raw materials:

· 20 bags of cement,
· 10 m³ of sand,
· 50 kg of colorants,
· 20 m of wire,
· 1’000 tiles.

Next, Mr. Garcia checks his records to find out how much he paid for each item:

· He paid LU 80’000 for 200 bags of cement,
· He paid LU 6’000 for 12 m³ of sand,
· Each kg of colorant costs LU 100,
· 100 m of wire cost LU 5’000.

Using this information Mr. Garcia determines that it cost LU 18’000 to produce 1’000 tiles.

What is the value of Mr. Garcia’s stock on the 1st of January? To find the answer to this question, make a copy of the Stock Record Format, and use the figures given above. Below, you will find the answer.

Now, make a copy of the Profit and Loss Statement Format and enter the figure in the field “Initial Value of Stock”.

Mr. Garcia also determines the stock on the 31^st of March and finds that it is LU 20’000. Please enter this figure in the field “Final Value of Stock” in the profit and loss statement.

2. Depreciation of Equipment and Workshop

Description	Value ($)	Yearly Depreciation ($)
Site/Buildings	3’000	200
Equipment	1’000	400

What is the yearly and quarterly depreciation, when the exchange rate is 100? Please enter the figure for the quarterly depreciation into the profit and loss statement in the field “Depreciation”.

3. Cash Transactions

Please prepare a cash book for Garcia’s Tile Factory. Enter the following cash transactions in the cash book and determine the transaction codes used for the profit and loss statement.

Remember: Investments and repay of loans are not expenses and, therefore, do not make part of the profit and loss statement.

· On the 1^st of January there are LU 60’000 in the cash box.

· On the 5^th of January Mr. Garcia buys plastic sheets for LU 5’000. The voucher number is 101.

· On the 10^th of January Mr. Brown pays last year’s invoice. The amount is LU 100’000 and the invoice number is 356.

· On the 15^th of January 200 bags of cement are delivered. Mr. Garcia pays LU 75’000. The invoice number is 102.

· On the 25^th of January Mr. Garcia pays his workers: LU 30’000. The voucher number is 103.

· On the 3^rd of February, Mr. Garcia buys office material for LU 2’000. The voucher number is 104.

· On the 7^th of February, Mr. Garcia starts an advertising action in the newspaper “Daily Mail” and pays LU 18’000. The invoice number is 105.

· On the 12^th of February, Mr. de Rivero fetches his tiles and pays LU 150’000. The invoice number is 106.

· On the 18^th of February, Mr. Garcia pays LU 5’000 for transport. The invoice number is 107.

· On the 21^st of February, new moulds are delivered. Mr. Garcia pays LU 70’000. The invoice number is 108.

· On the 25^th of February, Mr. Garcia pays his workers: LU 30’000. The voucher number is 109.

· On the 28^th of February, Mr. Domingues pays LU 100’000 for tiles he received. The invoice number is 110.

· On the 8^th of March, 20m³ of sand are delivered. They cost LU 5’000. The invoice number is 111.

· On the 11^th of March, Mr. Garcia pays for the repair of his vibrating table LU 10’000. The invoice number is 112.

· On the 17^th of March, Mr. Garcia has to pay the water fee of LU 10’000. The invoice number is 113.

· On the 25^th of March, Mr. Garcia pays his workers: LU 30’000. The voucher number is 114.

· On the 30^th of March, the interest for the first quarter has to be paid: LU 15’000. The invoice number is 115.

· On the 31^st of March, Mr. Garcia decides to draw LU 20’000. The voucher number is 116.

4. Profit and Loss Statement

Please prepare now the profit and loss statement for Garcia’s Tile Factory for the period from the 1st January to the 31st of March.

All the information you need to prepare the profit and loss statement is given above.

5. Answers to the Exercises

a. Stock Record

Figure

b. Depreciation

The total yearly depreciation is $ 600. The quarterly depreciation is one forth of that:

With an exchange rate of 100, the quarterly depreciation is 150 × 100 = LU 15’000. This figure is entered into the profit and loss statement.

c. Cash Book

Figure

d. Profit and Loss Statement

Figure

Appendix B: The Difference between Cash and Profit

1. The Question

In appendix A you find an exercise, where you make a profit and loss statement from a stock record, the depreciation summary and the cash book. There you find the following figures:

· The Retained Profit from the 1st January to 31st March is LU 63’000
· The Cash on Hand in the Cash Box on 31st March is LU 85’000

Question: Where does this difference come from?

2. Where the Difference Comes From

The difference between cash and profit can be explained by the following:

· Investments (“new moulds”) reduce the cash, but they are not expenses. Investments are irregular and large cash transactions. If they were included in the expenses, the result of the profit and loss statement would be distorted.

· Depreciation is an expense but it does not reduce cash.

· Loan Repayments reduce cash, but they are not expenses. Loan repayments are irregular and large cash transactions. If they were included in the expenses, the result of the profit and loss statement would be distorted. However, the costs of loans are taken into consideration. The loan interest is an expense (and also reduces cash).

· Changes in the value of stock change the profit but do not change cash.

3. Example

In the case of Garcia’s tile factory, the difference between cash and profit can be explained by the following calculations:

Final Cash			+ 85’000
	Less: Initial cash (On the 1st of January)	- 60’000
= Cash difference between 1.1. and 31.3.			+ 25’000
	Plus: Investments (reduced cash, but not profit)	+ 70’000
	Less: Depreciation (reduced profit, but not cash)	- 15’000
	Less: Stock Changes (reduced profit, but not cash)	- 17’000
= Retained Profit			63’000