Nursery ManagementUnderstanding and Managing Finance

Session 5

The Profit and Loss Account

In Session 2 we saw an example of a Profit and Loss account for a day’s trading in at a car boor stall.

Before we see an example of a ‘real’ Profit and Loss account, we need to understand: the idea of revenue the idea of expenses

Further Financial Terms

Income – An amount of money which comes in to, or is earned by, the business during an accounting period - sometimes called Revenue

Turnover - total value of sales over a given period – this is sometimes called Income or Revenue Its likely that most of your income will be received by

parents/guardians

So what is actually meant by the term Revenue? Revenue – technically this simply refers to the inflow of

assets, or the reduction in claims that arise as a result of trading operations.

Financial Terms

• Expenditure – An amount of money which has been spent by, or goes out from, the business during an accounting period.

• Cost - the amount of actual or notional expenditure incurred on or attributable to a specified thing or activity (fixed, variable, direct, indirect )

The Format of the P and L Account

Normally a Profit and Loss Account will consist of:

Sales (Turnover)Less Cost of Sales

= Gross ProfitLess Overheads

= Net profitLess Interest on Loans

= Profit Before TaxLess Tax

= Profit after TaxLess Dividends

= Retained profit for the year

Terms on the Profit and Loss Account

Turnover: Total value of sales over a given period - sometimes called Income or Revenue

Cost of Sales: The costs incurred in caring for the children in a given period

Overheads: Other costs incurred in running the business, but not directly related to caring for the children

Interest on Loans: Money paid to lenders for the privilege of borrowing money.

Tax: Money paid to the government as a contribution to the National Exchequer.

Dividends: Money paid to shareholders(of a limited company) as a ‘reward’ for investing in the company.

Turnover

In early years settings this will usually be fees for services

Subscriptions Interest earned ( for example if you have money

on deposit at the Bank) To all intents and purposes,

Income = Revenue = Sales = Turnover VAT is excluded from Sales figures (and all

other figures)

Cost of Sales (Direct Costs) Costs which are directly related to the cost of providing

the goods or service (Cost of Sales)

For example: Goods purchased for resale(for example tee shirts advertising your crèche)

Direct Labour costsRaw materials, Packaging, Energy

Direct Costs often vary with sales (though some Direct Costs can be FIXED)

Overheads (Indirect Costs) Operating Expenses Costs which are not directly related to child care. Costs which are incurred even when an organisation

produces no output. Often Fixed Costs For example: Administrative salaries

Advertising, Stationery, Rent and RatesInsurance, Bank chargesDepreciation

Indirect Costs do not (necessarily) vary with ‘sales’ Interest usually shown later

Interest on Loans

Includes Interest on Bank loans and other formal loan

arrangements (e.g. debentures). These are normally charged at some fixed rate e.g. 12% of the loan

Interest on Overdrafts (rates may be variable), and more expensive (e.g. up to 15%)

Does not include Money paid to shareholders in dividends Interest charged by creditors for late payment

Tax

Corporation Tax is charged on profits made after all costs and interest charges (but not dividends) have been accounted for.

In the examples in the slides, a ‘flat rate’ of 20% is used, to simplify calculations

For more on tax in the UK consult:

http://www.inlandrevenue.gov.uk/rates/corp.htm

Dividends Limited companies are financed primarily through

shareholding. Shareholders buy shares in the company. These may

have a face value ranging anywhere from 1 penny to thousands of pounds.

At the end of each financial period, the directors of the company may decide to issue dividends. This is money paid to the shareholders out of net profit after tax , as a reward for their continued investment.

The dividend paid does not affect the face value of the share.

Profit or (Loss)

There are many different sorts of profit: Gross Profit = Sales less Direct Costs Operating Profit = Sales less Direct Costs less

Indirect Costs Profit before tax = Operating Profit less Interest Profit after tax = Profit before tax less tax Retained profit = Profit after tax less dividends

Activity 1

Which type of Profit specifically might you be interested in if you were: A Shareholder The Inland Revenue The Nursery Manager The Managing Director

Activity 1 solution

Which type of Profit might you be interested in if you were:A Shareholder All types of profit, but specifically profit after tax, and the

amount that the company has offered in dividends and the retained profit.

The Inland Revenue Profit before TaxThe Nursery Manager Normally Turnover and Gross ProfitThe Managing Director All types of profit, but specifically the Retained Profit, which

will be reinvested into the company.

Sample Profit and Loss Account• The next slide shows a profit and loss account for a company

over a one-year period.• The format varies according to the type of business, but there

is a fairly uniform convention to structure the accounts in the following way:

Total Income:Less expenditure item #1Less expenditure item #2Less expenditure item #3 etc.

= Earned Surplus (Profit)

Turnover (Sales) (Income) £ 100,000

Cost of Sales (Direct Costs)Materials £10,000

Transport £ 5,000

Labour £15,000

Total Cost of Sales £ 30,000 30%

Gross Profit (Gross Margin) £ 70,000 70%

Overheads (Indirect Costs)Administrative salaries £18,000

Depreciation £ 5,000

Rent and Rates £ 4,000

Total Overheads £ 27,000 27%

Operating Profit (Net Margin) £ 43,000 43%Interest on loans £ 3,000

Profit before tax £ 40,000 40%Corporation tax due £8,000

Profit after tax and interest £ 32,000 32%Dividends payable £22,000

Retained Profit (Earned Surplus) £ 10,000 10%

Depreciation Methods

There are two main methods used: Straight-line depreciation = Cost of item

divided by number of years over which it is to be written off

Reducing balance = Current value x Depreciation%

Activity 2

Discuss the following:

Why does an increase in cash in the bank during a particular accounting period not necessarily mean that the organisation has made a profit?

Why is it important to distinguish between capital and revenue expenditure?

Why is it important to differentiate between indirect and direct costs?

Activity 2 – Possible Solution

Increase in cash in the bank could be the result of: a loan, payment of a previous debt, selling off an asset, even selling goods at a loss!

None of these incurs profit.

Capital expenditure buys things still owned by the company. Revenue expenditure ‘disappears’.

Indirect costs need to be paid even if you don’t sell anything; in difficult times overheads need to be cut.