In a Nutshell (III).Finance: Accounting (II)

The profit and loss account (income statement)

The difference between profit and cash: Cash is immediate and takes account of nothing else. Profit, however, is a measurement of economic activity that considers other factors that can be assigned a value or cost.

The structure of the profit and loss statement

This account is set out in more detail for a business in order to make it more useful when it comes to understanding how a business is performing. In practice we have four levels of profit:

• Gross profit is the profit left after all costs related to making what you sell are deducted from income.
• Operating profit is what's left after you take away the operating expenses from the gross profit.
• Profit before tax is what is left after deducting any financing costs.
• Profit after tax is what is left for the owners to spend or reinvest in the business.

Other terms:

EBITDA: Earnings before interest, taxes, depreciation and amortization.

EBIT: Earnings before interest, taxes and depreciation

High Note extended profit and loss account:

• sales (and any other revenues from operations);
• cost of sales (or cost of goods sold);
• gross profit – the difference between sales and cost of sales;
• operating expenses – selling, administration, depreciation and other general costs;
• operating profit – the difference between gross profit and operating expenses;
• non-operating revenues – other revenues, including interest, rent, etc;
• non-operating expenses – financial costs and other expenses not directly related to the running of the business;
• profit before income tax;
• provision for income tax;.
• net income (or profit or loss).

The Balance Sheet

A balance sheet is a snapshot picture at a moment in time. On the one hand it shows the value of assets (possessions) owned by the business and, on the other, it shows who provided the funds with which to finance those assets and to whom the business is ultimately liable

Total assets = Fixed assets + Current assets.

Total liabilities = Share capital and reserves + Borrowings and other creditor

Filing Accounts

A company's financial affairs are in the public domain.

Financial ratios

The trading performance of a company for a period of time is measured in the profit and loss account by deducting running costs from sales income. A balance sheet sets out the financial position of the company at a particular point in time, usually the end of the accounting period. It lists the assets owned by the company at that date matched by an equal list of the sources of finance.

Comparing the current year's figure with the previous year's figure can identify changes in some of the key items, but conclusions drawn from this approach can be misleading.

It's more easy to compare two trading performance using ratios, a relationship between two quantities, normally expressed as the quotient of one divided by the other

Analysing accounts

The main analytical approach is to examine the relationship of pairs of figures extracted from the accounts. A pair may be taken from the same statement, or one figure from each of the profit and loss account and balance sheet statements. When brought together, the two figures are called ratios. It serves us for measure and analyse about our objectives, usually:

• Making a satisfactory return on investment
• Maintaining a sound financial position
• Achieving growth, or better... growth of ROI

Glossary of terms: http://accountingforeveryone.com/accounting_glossary/