Profit and Loss accounts

Question 1

Define a profit + loss account

Answer 1

An accounting statement showing an organisation’s sales revenue over a trading period, and all the relevant costs incurred in earning that revenue (income and expenditure)

Question 2

Define cost of sales

Answer 2

All costs of production used when
manufacturing guitars and ukuleles. Any direct costs, such as raw materials, wages, used in the production process.
opening stock + purchases - closing sales

Question 3

Define Gross Profit

Answer 3

The difference between the revenue from selling the product and the direct costs of making it.
Revenue - Cost of Sales

Question 4

Define Net Profit

Answer 4

It is the profit that belongs to the sole trader following the reduction of all expenses from the gross profit. The sole trader has to pay income tax on this profit.
Gross profit - expenses

Question 5

Explain profitability ratios

Answer 5

Profitability measures a business’ total profit against resources used in making that profit. On its own, profit is a relatively meaningless figure – it needs comparing against figures such as turnover.
These profitability ratios are used to asses how well the business is performing. They concentrate on
profit, capital employed and turnover

Question 6

Explain gross profit margin

Answer 6

Measures the proportion of money left over from revenues after accounting for the cost of
goods sold.
Gross Profit / Revenue x 100

If the gross profit margin is 30%, this means that the business’ cost of sales are 70% of its turnover
(because turnover = cost of sales + gross profit).

Question 7

Reasons for change in the gross profit margin

Answer 7

• increase or decrease in sales turnover
• increase or decrease in cost of goods sold.

Question 8

Explain Net Profit Margin

Answer 8

Measures how much out of every pound of sales a company actually keeps in earnings.
Net Profit / Revenue x 100

Question 9

Reasons for change in the Net Profit Margin

Answer 9

• increase or decrease in sales turnover
• increase or decrease in cost of goods sold
• increase ore decrease in expenses.

Question 10

How to improve profit

Answer 10

> Increase Revenue
- increase selling price (PED)
- increase sales (marketing)
Reduce Costs
- Reduce waste (lean prod)
- Negotiate with suppliers
- Cost control

Question 11

Evaluate profitability ratios (GPM/NPM)

Answer 11

> Trend Analysis: Tracking ratios over time reveals the direction of a company’s financial performance, identifying positive or negative trends.
Industry Benchmarking: Comparing ratios provides context for understanding its performance relative to competitors.
Qualitative Factors: Consider qualitative factors like pricing strategies, cost controls, and competitive landscape to gain a comprehensive understanding of profitability.
In conclusion, profitability ratios offer valuable insights into a business’s financial health and operational efficiency. By understanding and analyzing these ratios, businesses can assess their performance, identify areas for improvement, and make informed decisions to enhance profitability.