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ANALISYS OF FINANCIAL PERFORMANCE
The measurement of profit is probably the most important function of accounting. Investors, managers, bankers and others are interested in knowing how well a business is doing. The profit and loss account (income statement) shows the results of the flow of activity and transactions and is designed to report the profit performance of a business for a specific period of time, such as a year, quarter or month.
The purpose of income statement is to measure and report how much profit the business has generated over a period.
The measurement of profit requires that the total revenues of the business generated during a particular period, be calculated.
Revenue is simply a measure of the inflow of assets (cash or amounts owed to a business by debtors) or the reduction in liabilities which arise as a result of trading operations.
It is not necessary for a business to receive cash before recognizing that revenue has been earned. The accruals concept recognizes revenue which arises from the sale of goods or services on credit.
The total expenses relating to the period must also be calculated. An expense represents the outflow of assets (or increase in liabilities) which is incurred as a result of generating revenues.
Expenses are goods and services consumed in operating a business or other economic unit.
The income statement for a period shows the total revenue generated during a particular period and deducts from this the total expenses incurred in generating that revenue. The difference between the total revenue and total expenses will represent either profit (if revenues > expenses) or loss (if expenses > revenues).
Where revenues and expenses are equal for the period, the business is said to break even.
Profit (loss) = total revenue --- total expenses incurred to generate the revenue
The income statement and the balance sheet (B.S.) are closely related.
The profit and loss account can be viewed as linking the B.S. at the beginning of the period with the B.S. at the end of the period. Thus, at the commencement of business, a B.S. will be produced to reveal the opening financial position. After an appropriate period, an I.S. will be prepared to show the wealth generated over the period. A B.S will also be prepared to reveal the new financial position, at the end of the period covered by the I.S.
The B.S. will incorporate the changes in wealth which have occurred since the previous B.S. was drawn up.
The effect of making profit (loss) on the B.S. means that the B.S. equation can be extended as follows:
assets = capital + (--) profit (loss) + liabilities
assets = equity + (revenues expenses) + liabilities
Expenses and revenues are classified into three categories:
a) operating expenses and revenues;
b) financial expenses and revenues;
c) extraordinary expenses and revenues.
Expenses may be classified into 2 categories:
٭ by type operation or by function
٭ by type of expenditure or by nature.
Accordingly, there may be distinguished 2 formats for Income Statement (function, nature)
a) Operating expenses and revenues
Operating expenses Operating revenues
٭ expenses relating to inventories ٭ turnover
raw materials sales of finished goods,
consumables semi finished goods,
٭ third parties services residual products
maintenance, repair expenses services rendered
insurance premium rental and royalty
٭ other third party services income
commissions and fees sales of merchandises
transport revenues from
bank commissions sundry activities
٭ other taxes, duties ٭ variation inventory
٭ personnel expenses ٭ subsidies for operating
٭ other operating expenses activities
bad debts written off ٭ other operating revenues
other bad debts
٭ depreciation and provisions other operating revenues
b) Financial expenses Financial revenues
٭ interest expense ٭ interest revenue
٭ foreign exchange losses ٭ foreign exchange gains
٭ discounts allowed ٭ discounts received
٭ losses on disposal of ٭ revenues from long term
financial investments financial investments
٭ revenues from disposal
of financial investments
c) Extraordinary expenses Extraordinary revenues
٭ expenses related to ٭ revenues from subsidies
natural disasters and other for extraordinary events
extraordinary events and other similar revenues
Operating activity + financial activity = ordinary activities
Extraordinary items are those items which derive from events or transactions outside the ordinary activities of the business and which are both material and expected not to recur frequently or regularly. They do not include items which, though exceptional on account of size or incidence, derive from ordinary activities of the business.
Operating revenues operating expenses = operating profit (loss)
Financial revenues financial expenses = financial profit (loss)
Ordinary revenues ordinary expenses = ordinary profit (loss)
Extraordinary revenues extraordinary expenses = profit (loss)
on extraordinary activity
Profit (loss) on ordinary activities + Profit (loss) on extraordinary = activities = Profit (loss) for the financial year
less (Income tax)
= Net Profit (loss) for the financial year.
By type of operation or function operating expenses may be classified in:
- cost of sales;
- distribution costs;
- administrative expenses.
Turnover -- cost of sales = gross profit or loss. This represents the profit from simply buying and selling goods without taking into account any other expenses or revenues associated with the business.
4. Income statement formats
Income statement Format 1 (by function or type of expense)
2. Cost of sales
3. Gross profit or loss
4. Distribution costs
5. Administrative expenses
6. Other operating income
7. Income from shares in group companies
8. Income from shares in related companies
9. Income from other fixed - asset investments
10. Other interest receivable and similar income
11. Amounts written of investments
12. Interest payable and similar changes
13. Tax and profit or loss on ordinary activities
14. Profit or loss on ordinary activities after taxation
15. Extraordinary income
16. Extraordinary changes
17. Extraordinary profit or loss
SEPARATE THE FOLLOWING ELEMENTS INTO A CORRECT BALANCE SHEET:
Finished goods 1000
Financial leasing liabilities 2000
Salaries payable 6000
Shareholders capital 90000
Cash on hand 3000
Deferred revenues 300
Sundry debitors 4000
Taxes payable 1500
Land assesments 9000
Cash at bank 180000
Notes payable 11000
Accrued revenues 500
VAT receivable 2000
Retained earnings ???
Trade marks 16000
Reevaluation reserves 8000
Marketable securities 12000
Income tax payable 2500
During the current month, the subsequent transactions occurred:
30% from clients are cashed into the bank account
purchase of merchandise for 2000 $, the payment being due leter
incorporating 25% from reevaluation reserves into shareholders capital
acquisition of raw materials for 4000 $; half of them is paid immediately from cash, the other weeks
the supplier of merchandise is paid with a note payable
a building is purchased and paid with a long term credit of 110000 $
a rent is cashed in advance for 500 $
all sundry debitors are cashed in
the salaries are paid from cash at bank
10% from leasing liability is paid from bank account
the profit is used 60% to pay dividends
the VAT receivable is cashed into cash on hand
a long term credit is cashed into the bank account for 7000 $
an invoice for special services is payd in advance for 5000 $
the rest of clients changed into notes receivable
marketable securities are purchased for 4500 $
18. Tax on profit or loss
19. Other taxes not shown under the above items
20. Profit or loss for the financial year
Income statement - Format 2 (by nature of expenses)
b Other external changes
6. Staff costs:
a) wages and salaries
b) social security costs
c) other pension costs
7. a) Depreciation and other amounts written off tangible and intangible fixed assets
b) Exceptional amounts written off current assets
8. Other operating changes
9. Income from shares in group companies
10. Income from shares in related companies
11. Income from other fixed assets investments
12. Other interest receivable and similar income
13. Amounts written off investments
14. Interest payable and similar changes
15. Tax on profit or loss on ordinary activities
16. Profit or loss on ordinary activities after taxation
17. Extraordinary income
18. Extraordinary changes
19. Extraordinary profit or loss
20. Tax on extraordinary profit or loss
21. Other taxes not shown under the above items
22. Profit or loss for the financial year
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