Menu
Home
Log in / Register
 
Home arrow Business & Finance arrow Executive finance and strategy
< Prev   CONTENTS   Next >

Gross profit

This is the difference between sales and the cost of sales. Its importance is as a performance and control measure. The accuracy and worth of the measure thus depends on the clear and consistent definition of cost of sales defined above.

Table 3.4 shows a P&L account for a simple business.

The P&L account is for a small trading company and for the size of business the layout is probably quite adequate. However, (monthly) accounts of a business of this size are also used for management purposes and some grouping of the overhead costs is helpful; even the simplest accounting software will produce some analysis of expenses.

For the above figures, grouping as shown in Table 3.5 may be helpful.

For larger enterprises, management accounts will be analysed in much detail and software allows reviewers to 'drill down' to obtain more detailed analysis; ultimately it should be possible to look at the individual costs that make up the figure under a particular heading. There are endless possibilities regarding the analysis of expenditure, but the overriding principle should be to have the minimum necessary to be able to properly manage the business, to understand how your strategy is progressing - and with not too many KPIs (key performance indicators - see Chapter 7).

The income statement, the IASB/FASB preferred term for the P&L account, requires a statement with only the principal figures, and the content and layout of these are covered in Chapter 6 on published financial statements.

What do P&L accounts reveal about a business? Hopefully that your strategy is working!

It is important to remember, when interpreting any financial statements, that the figures are not the creation of an accountant, but should represent the business for which they are assembled. Careless record keeping (bookkeeping), inappropriate and inconsistent rules (accounting policies) or deliberate misstatement (fraud!) will result in unreliable statements, but it is assumed that the reader is dealing with reliable statements.

TABLE 3.4 Profit and Loss account for the year ended 31 December 20XX

Profit and Loss account for the year ended 31 December 20XX

Probably the most important use of P&L account figures is as an 'affirmation' statement. A manager should have a good idea of how matters are progressing and the detailed P&L account should confirm this. However, we are all busy people and may miss or perhaps ignore issues which will affect our income, costs and thus results. The review of detailed P&L accounts is a vital management exercise for controlling and directing a business. Finally, P&L data collected and analysed over time using graphs can make clear trends or aberrations in performance, which will be very useful in monitoring and formulating strategies.

TABLE 3.5 P&L account with costs classified

P&L account with costs classified

The following illustration is an example of what is meant by the above assertion that the P&L account should represent the business for which it has been prepared. The P&L accounts shown in Table 3.6, with gross profit and costs expressed as percentages of sales, are of three different types of business. Have you an idea as to what the businesses might be?

TABLE 3.6 Three P&L profiles

P

Q

R

Sales

100%

100%

100%

Cost of sales

Materials

22%

19%

51%

Wages/salaries

20%

0%

0%

Overheads

13%

0%

0%

Depreciation

15%

0%

0%

Gross profit

30%

81%

49%

Wages/salaries

8%

19%

17%

Occupancy

4%

27%

14%

Administration

6%

13%

5%

Depreciation

2%

12%

3%

Total costs

20%

71%

399^

Operating profit

10%

10%

10%

While a more detailed description of the businesses activities would assist in comprehending the figures, at this stage the point is being made that the figures should be of the business described and not just the creation of a bookkeeper or accountant.

The headings against which figures are disclosed, as well as the size of the numbers, is very important when analysing figures. In this example the manufacturer will have sizeable material and wage costs as part of the cost of manufacture - cost of sales. An hotelier might consider only the costs of staff and bought-in food, liquor and other consumables as being cost of sales. A retailer will normally consider the cost of sales to comprise solely the cost of bought-in merchandise for retail.

The overall interpretation of the figures is as follows, where P is a manufacturer, Q an hotel and R a retailer.

The manufacturer P has considerable costs in materials, wages and depreciation, as would be expected. General expenses, wages, occupancy, administration costs and office depreciation are relatively low.

The hotel Q has considerable staff costs, with noticeably high occupancy costs.

The retailer R has cost of sales comprising only materials - merchandise bought in for resale, staff and occupancy costs are the only other material expenses.

The point of the above analysis is not that you could instantly identify a business from the P&L account structure, but rather that the headings and amounts found in a P&L account will relate to the business being reviewed.

I hope that the above matching appears reasonable to the reader; it is obviously easy to do this exercise with knowledge of the answer! The point with interpretation of figures is that information should be used firstly to identify key figures. Once key figures are understood and matched, the remainder should fall into place.

 
Found a mistake? Please highlight the word and press Shift + Enter  
< Prev   CONTENTS   Next >
 
Subjects
Accounting
Business & Finance
Communication
Computer Science
Economics
Education
Engineering
Environment
Geography
Health
History
Language & Literature
Law
Management
Marketing
Philosophy
Political science
Psychology
Religion
Sociology
Travel