## Tuesday 14 March 2017

### P5 Unit 2 Interpreting the contents of a P&L account and Balance Sheet

Dear Year 12

for P5 of the current Unit 2 you need to be able to interpret the contents of a Trading Profit and loss account and a balance sheet for a selected company.

To do this you will be given a profit and loss account and a balance sheet for a business and you will need to provide a written interpretation of the key elements of both and explain the purpose of each element.

To do well in this you will need to learn some accountancy terms and equations:

Financial statementsProfit and loss accounts and balance sheets in a nutshell

Equations that you are required to understand

Profitability Ratios  How can these be used by the business?

• Gross Profit Percentage or margin = Gross Profit / turnover x 100

• Net Profit Percentage or margin = Net Profit / turnover x 100

• Return on Capital employed (ROCE) - Net Profit before intrest and tax (EBIT) / capital employed (inc shareholders fund) x 100

Liquidity (solvency) Ratios How can these be used by the business?

• Current ratios = current assets / current liabilities

• Acid Test ratio = current assets - stock / current liabilities

Efficiency ratios How can these be used by the business?

• Debtors Payment or collection period = debtors / credit sales x 365 (total number of days it takes debtors to pay)

• Creditor days = Trade payables / cost of sales x 365

• Stock Turnover = cost of sales / average stock (stock turnover number of times)

• Stock turnover shown in days = average stock / cost of sales x 365

Key terms that you are required to understand

Liquidity - measure of a firms ability to meet short term cash payments

Gross Profit - sales revenue - cost of goods sold (cost of materials used to prioduce the quantity of goods sold)

Cost of sales = opening stock plus purchases - closing stock)

Net Profit - Gross profit - other expenses (e.g. rent and advertising)

Solvency - when a business is able to pay its expenses as it has money available within the business

Debtors - customers who have purchased goods or services on credit meaning that they are in debt to the business as they owe it money.

Average stock - The opening stock plus the closing stock divided by two

To get a distinction in this challenge you really need to be having a discussion about the benefit of the Key Performance Indicators that you have calculated.

An entrepreneur running a carpet business will probably know a lot about carpets and fitting carpets but will not be an expert in accounts and reading profit and loss accounts and balance sheets.

What will the information that he or his accountant has calculated tell him about his business?

Is knowing this information better than not knowing ? Why?

Can you find any carpet industry standard accountancy ratios for the carpet industry to compare the figures that you have calculated against?

If the owner of the carpet company can compare his business ratios to other businesses in the same industry how will that help him make decisions about running his business in the future?

What would happen to the carpet business if it was not tracking its own  financial performance ?  Have any other carpet companies entered the market, gone bust or been bought out in the last 12 months? Who did this include and why did this happen? Were those businesses more or less efficient than the business that you have been studying?

Finally if the Carpet business was put up for sale how would the ratios that you have calculated support this ?