Trading accounts and profit and loss accounts

At the end of every trading year a business prepares final accounts. These provide a financial summary of all their trading activity during the year.

The trading account shows the gross profit [Gross profit: The difference between sales revenue and the cost price of these sales. ] (or loss) that the company has made. Profit is the money made by the business and equals income minus expenses.

The profit and loss account shows the net profit [Net profit: Gross profit minus expenses (eg wages, rent, rates, advertising etc) leaves net profit. ] (or loss) made. The trading account and profit and loss account are often combined as one trading and profit and loss account so that both the gross and net profit can be displayed in the same set of accounts.

Sample question

You may be given questions on the accounts of a company like Go Faster Sports, a high-street retail outlet.

The first part of the accounts is the trading account. Make sure you understand the following business terms:

Turnover [Turnover: Total revenue or income from sales ie all the money a business receives from selling goods or services. ] shows the amount of revenue earned by the firm through the sale of goods at the marked up price [Marked up price: The price after the company has added its own profit margin on top of the cost of producing the goods. ].

Cost of sales shows how much they have spent on buying the goods at cost price before the firm has added its own profit margin. It is divided into three sections:

1. Opening stock is the value of stock remaining unsold from the previous year.
2. Purchases are the amount spent on new stock during the current year.
3. Closing stock is the value of stock left unsold this year to be carried forward.

The opening stock and purchases are added together and then the closing stock is subtracted to give the cost of sales total of £100,000. This amount is then subtracted from the turnover of £200,000 to give a gross profit of £100,000.

The account then continues with the profit and loss account. It shows the rest of the annual expenditure which is the normal cost of running a business, plus depreciation [Depreciation: Loss of value through wear and tear. ] and bad debts [Bad debts: Amount owed to a firm by a customer that won't be recovered. ]. These are deducted from the gross profit to give the true profit: the net profit [Net profit: Gross profit minus expenses (eg wages, rent, rates, advertising etc) leaves net profit. ].

Depreciation is an estimate of the loss in value of major assets [Assets: Everything a firm owns. ] like vehicles, furniture and machinery through wear and tear. This is useful to know for resale purposes.

Bad debts represent the amount of money written off through goods sold on credit which will never be paid for.

Balance sheets

A balance sheet shows the value of a business. It shows what it owns and owes, its assets and its liabilities [Liabilities: Everything a firm owes. ] on a particular date.

Look at a balance sheet for Go Faster Sports.

Make sure you understand these business terms:

• Fixed assets shows the current value of major purchases that help in the running of the business, like delivery vans or PCs. In this case it is £40,000. This amount should either allow for depreciation in value, or show depreciation being subtracted on the balance sheet.

• Current assets shows the cash or near-cash available to the firm. This includes stock ready to sell, money owed to them by debtors, and cash in the bank. Here the amount comes to £30,000.

• Current liabilities shows the short-term amounts that the firm owes. In this case they may have a short-term loan for £5,000.

  To calculate the net current assets, the current liabilities are subtracted from the current assets:

  £30 000 - £5,000 = £25,000

  This amount is added to the fixed assets value to give the net assets total:

  £40,000 + £25,000 = £65,000

• Business finance All businesses have to be financed. Initially this comes from the owners through the capital they invest, or from taking out long-term loans. Later on, it could be from share capital. All the financing has to be shown in this section of the accounts, and is added together to give the value of the firm. In this case, the only financing is the capital and the net profit for the year:

  £45,000 + £20,000 = £65,000

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