Finance and Accounts, 8 May 2007

Finance and Accounts

1. Key Terms
2. Break Even
3. Purpose of Accounts
4. Profit and Loss Account - Flow
5. Balance Sheet - Snapshot

Key Terms

1. Costs
2. Revenue
3. Profit/Loss

Costs

Fixed – are not influenced by the amount produced but can change in the long run e.g., insurance costs, administration, rent, some types of labour costs (salaries), some types of energy costs, equipment and machinery, buildings, advertising and promotion costs

Variable – vary directly with the amount produced, e.g., raw material costs, some direct labour costs, some direct energy costs

• 
  Total Costs (TC) = Fixed Costs (FC) + Variable Costs (VC)
• 
  Average Costs = TC/Output (Q) - AC (unit costs) show the amount it costs to produce one unit of output on average
• Marginal Costs (MC) – the cost of producing one extra or one fewer units of production
  -MC = TCn – TCn-1

Revenue

• Total Revenue – also known as turnover, sales revenue or ‘sales’ = Price x Quantity Sold
• TR = P x Q
• Price – may be a variety of different prices for different products in the portfolio
• Quantity – could be global sales

Profit

1. Profit = TR – TC
2. Normal Profit – the minimum amount required to keep a business in a particular line of production
3. Abnormal/Supernormal Profit – the amount over and above the amount needed to keep a business in its current line of production
   

Break Even

TC=TR

1. Occurs where Total Costs = Total Revenue
   –Start-up costs – fixed costs
   –Running costs – variable costs
   –Revenue stream depends on price charged
   –‘Low’ price – need to sell more to break-even
   –‘High’ price – lower level of sales required before breaking even

Purpose of Accounts

1. Provide Information
2. Monitor Activities
3. Transparency
4. Reduce Chance of fraud

• Provide information for stakeholders – customers, shareholders, suppliers, etc.
• Provides the opportunity for the business to monitor its own activities
• Provides transparency to enable the firm to attract investment
• Reduces the chance for fraud – not 100% successful!!
  

Profit and Loss Account - Flow

1. Gross Profit
2. Net ( operating profit )
3. Profit after Tax
4. Dividend
5. Retained Profit

• Shows the flow of sales and costs over a period
• Shows the level of profit or loss made
• Shows what has been done with the profit or loss
  

• Profit and Loss Account for British Airways plc
  Source: http://www.bized.ac.uk/cgi-bin/ratios/ratiodata.pl
• Turnover – the revenue earned over the year
• Cost of Sales – the variable costs, how much it cost the firm to produce what it has sold – not to be confused with sales revenue!
• Gross Profit = turnover – cost of sales
• Operating Expenses – the fixed costs
• Operating or Net Profit = Gross profit – operating costs
• Subtract other costs and expenses incurred to get profit before tax
• Subtract interest payments to get profit on ordinary activities before tax
• Subtract tax due to get profit on ordinary activities after tax
• Final section called ‘appropriation account’ – shows where the profit/loss is going
• Dividend – the share of the profit returned to shareholders
  Retained Profit – the amount kept back for future investment, etc.

Balance Sheet - Snapshot

1. Source of Funds
2. Use of Funds

• A snapshot of the firm’s position at a point in time
• Shows what a company owns (assets) and what it owes (liabilities)
• Balance Sheet shows what assets a company has (use of funds) and where the money came from to acquire those assets (source of funds)

• Fixed Assets – assets not used up in production or lasting longer than one year – equipment, buildings, machinery, etc.
• Fixed assets can be tangible – i.e. physical items or intangible – i.e. brand name, goodwill.
• Current Assets: assets that are used up during production and which are likely to yield cash in the coming year – for example, stock will be sold and debtors owing the business money will pay up!

• Subtracted from the assets are the money the company owes to creditors – suppliers for example
• And to those who are longer term creditors – loans, mortgage on property etc
• This leaves us with ‘Net Assets’
• The funds to acquire these assets must have come from somewhere – the next section tells us where it came from.
• The funds to acquire these assets must have come from somewhere – the next section tells us where it came from.
• The total capital employed must be the same as the sum of the net assets – hence the term ‘balance’ sheet!
• A guide to the structure of the assets of a company
• Gives a guide as to the degree of working capital – the amount the company has to be able to pay its everyday debts (current assets – current liabilities)
• Shows the total value of a firm at that moment in time