Most businesses calculate a cost (as a percentage) that they can use to calculate the real profits.
Your organisation will have a percentage figure for this calculation; such as 15%. The example that gave a profit of $150.00 is, therefore, decreased by 15% = $127.50. The overhead percentage of 15% is not intended to be a realistic indication of the overhead percentage in any business. The overhead percentage is a variable that must be calculated for each individual concern. A profit and loss report will give a better representation of the business when taken over as long a period as possible. Learn more about Accoutning and Bookkeeping course information via this website and run your own acccounting and bookkeeping business.
Note: It is not possible to make a profit or a loss on GST, therefore GST figures should not be shown on a profit and loss report.
Gross profit is a simple calculation which subtracts the amount of purchases from the cost of sales.
Operating profit deducts other business expenses from the previously calculated gross profit.
Not all profit and loss sheets will have the same format; they might, for instance, show percentages rather than dollar figures. Your organisation will have guidelines for formatting and printing profit and loss reports.
Financial cost analysis
Many organisations identify their operational costs by using computer accounting systems or electronic spreadsheets which are fast, accurate and efficient. If the organisation operates a computer accounting/ costing system, it can readily access cost figures from the appropriate person/ department.
Before you can cost products or services effectively, analysis of the following costs is required:
- labour (including all salaries and on-costs)
- materials/ stock
- equipment/ project
- overheads (such as payroll, leases/ rent, vehicles, telephone, etc)
Ratio analysis is the analysis of performance through ratios or comparisons, and is important in business decision-making. Ratio analysis provides a means of examining trends and comparing performance to other firms in the industry. Commonly used ratios include liquidity ratio (cash assets/ cash liabilities), average debtors (trade debtors/ average daily credit sales) and inventory turnover (cost of goods sold/ average inventory).
Ratios are not just a device used by accountants, but a useful tool that identifies strengths and weaknesses of a business and leads to questions about performance that should result in action.
Ratios can also be used to set performance targets. For example, a business seeking to improve its cash flow position might do so by setting targets to reduce average debtors and/or inventory turnover. Understanding the relationship between these items and their impact on cash flow gives greater control over the business and the ability to clearly communicate performance objectives.
Ongoing capital is the finance required to sustain the business operations. It can include the amount of cash that is needed for the business to remain liquid. Ongoing finance will often vary depending on the phase of the business life cycle and the overall financial plan for the business, for example, it might be greater in times of expansion.
Internal and external budget factors
Accrual versus cash accounting
Accrual accounting records income and expenditure when they have occurred, not necessarily when you have received the income or paid the expense. For example, a lay-by sale might be recorded in total when the product is sold, even if you have not received the full purchase price at that time. Expenses such as electricity and insurance might be costed across whole financial year (as you have used electricity and insurance each month) rather than being budgeted for once a year or every three+ months. These types of expenses are called prepaid or accrued expenses.
Similarly, income can be received before a service is delivered (prepaid income) or after a sale (accrued income). The business will still have to prepare and monitor cash flow in order to ensure they can meet their debts; however, under the accrual system, they will budget and report on when the income was earned or the expenses were incurred regardless of when the money was received or expended.
Cash accounting records income and expenditure only when the actual money has been received or paid. Most businesses use accrual accounting as it provides a more realistic analysis of the true financial picture. Senior management or accounting personnel will advise you on how to treat certain expenses and income based on the organisation’s system and policy.