The Profit and Loss Account

Objective:	To enable participants to produce and use a profit and loss account.
Duration:	120 minutes

Session Guide:

1. Ask a participant who has a full time business, but is unlikely to be keeping complete records of revenues and costs, whether she does in fact know on a regular basis how much money her business is making or losing; when you have identified someone who does not, state that the class will now produce a "profit and loss account" for her business, which will be at least as accurate as her memory for a few vital facts.

2. Ask the chosen participant how much her sales amounted to in the last complete month; she may find it difficult to remember, but elicit from other participants suggestions as to how an approximate figure can be arrived at even if no records have been kept and the owner does not remember the total of sales in money terms; elicit suggestions such as:

· the avarge number of meals, dresses, chickens, eggs, or whatever the products are which were sold each day, week or month, times the average price charged for each

· if the owner cannot remember the above, the total amount of raw materials used, such as sacks of flour, meters of cloth or bags of cement, convened into the expected number of products this would allow to be made and sold.

Ensure that both cash and credit sales are included, and that cash received for credit sales made in previous months is excluded.

Stress that these only give very approximate figures, but such figures are better than nothing; remind participants that if they keep a cash book and debtors record as discussed in the earlier session both revenue and money spent can be easily extracted from the records.

3. Write down the figures for sales in a month, and then elicit the cost of raw materials used in the same way as the figure for sales revenue. A suggestion on how to lay out the figures of a profit and loss account in a simple way is given on the last page of this session guide.

Ask participants why the amount of money spent on raw materials in a month may not be the right figure to use for the cost of raw materials used in the month; if necessary, ask participants to think not of a month's sales but one day's sales; why cannot a tailor, for instance, calculate her profit for a day by taking the amount she spent on cloth and other supplies that day from what she sold?

Elicit the response that she probably does not buy cloth every day, and may in fact buy no cloth at all for some days, and then buy enough on one day for far more dresses than she can make in that day; the level of STOCKS of cloth goes up and down, so that the amount of stock USED is what should be set against the sales, not the amount of money SPENT on that particular day.

4. Ask the participant whose results are being used as an example whether her stocks of materials are always more or less the same at the start and at the end of each month; if they are, and are always likely to be, it may be reasonable to use the amount SPENT as the amount USED; in most businesses, except those with very perishable products which have to be sold each day, the stocks vary from one period to another.

Ask participants to suggest how the amount USED can be calculated, if the amount purchased, and the amount in stock at the beginning and at the end are known; show, if necessary by using sticks of chalk or other hems as a demonstration, how the calculation is done:

amount USED in a period

equals

amount in stock at start

plus

amount added to stock during period

less

amount in stock at end of period.

5. Stress that the actual amounts in stock must be counted at the end of each period for an accurate calculation of the profit or loss. Discuss the various approaches to stocktaking in various types of business; stress that it is necessary not only for calculating profit or loss, but also to find out if there has been any pilfering, to throw out damaged stock and to ensure that everything is in good order.

6. Ask the chosen participant for her estimates of stock at the beginning and end of the month she is describing, and for the amount purchased; carry out the calculation as above, and take the result from the revenue.

Show that this is the "Gross margin" or "Gross profit" for the period; ask the participant what other expenses she had during the period. Elicit, if necessary by asking others to suggest what has been omitted, items such as:

· wages paid to any employees

· wages or salary paid by the owner to herself (stress that this is often omitted, and discuss the problems that may arise when a one-woman business where no charge has been made for the owner's wages expands and employs others; there is a sudden increase in costs which may destroy the basis on which goods have been priced and sold)

· rent, electricity, water, licences

· maintenance of equipment

· any supplies such as stationery, lubricants or other items which are used but not directly related to production like cloth, flour or timber

· some allowance for the cost of replacement of equipment; some participants may be familiar with the concept of depreciation; explain this and show how both inflation and changes in equipment designs make this of little use as a way of actually ensuring that a business has enough money to buy new equipment when it is needed, but show that some allowance is needed for this cost

· any other cost items such as interest payments, taxes, or transport charges for goods or people.

7. Take the total of these other items from the "gross margin" to show the actual profit or loss. Ask the participant to state whether this is higher or lower than she expected; ask her, and others, to suggest how this information might be used to improve the profitability of the business and elicit suggestions such as:

· to compare performance from one period with another, in order to see whether progress is being made

· to relate various costs to sales revenue and to one-another, such as materials to revenue, wages to revenue, materials to transport costs and others as participants may suggest

· to help the owner to decide whether she and/or any other owners should make any withdrawals from the business, in addition to whatever wage or salary she is drawing

· to help calculate costs and thus to set prices.

8. If rime allows, go through one or more additional participants' figures in the same way, allowing other participants to ask the questions so that all are aware of the questions that must be asked.

9. Suggestion for the lay-out of a simple profit and loss account:

PROFIT AND LOSS ACCOUNT FOR MONTH XYZ

Sales			500
- Costs:
opening stocks		100
+ purchases		50
stocks at the end of the period		70
		-----
= stocks used during the period			80
			-----
Gross margin or gross profit			420
- Other Expenses:
	· wages	100
	· rent	50
	· supplies	20
	· depreciation	50
	· transport	10
	· repayment of interest, taxes	10
		------	240
			------
Net Profit			180
			=====

HANDOUT 1: THE PROFIT AND LOSS ACCOUNT

The Profit and Loss Account is a statement of the income and the expenditure of a business over a period; the business owner should decide for herself how frequently she needs to produce it.

Earnings not Cash

The income includes amounts which have been earned but have not yet been paid for, and items which have been used, whether they were paid for during, before or after the period, because they were bought or sold on credit. The CASH FLOW statement shows how the CASH moves, while the Profit and Loss shows what has been EARNED and USED.

The Use of Equipment

The cost of "wear and tear" of equipment is shown by DEPRECIATION; the amount is calculated by dividing the cost of the equipment by the years it will last, and including the resulting amount as the cost of using that equipment for a year. Remember, inflation means that the amount included for depreciation will hardly ever be enough to pay for new equipment.

The Amount of Stocks Used

The PURCHASES of stocks during a period are not usually the same as the the amount USED, because the stocks at the beginning and the end of the period are not usually the same; the amount USED is calculated as follows:

Stocks at the beginning of the period
PLUS

Stocks purchased during the period

LESS

Stocks remaining at the end of the period

EQUALS

Stocks used during the period

The Profit and Loss Account is used to find out what profit has been made so that the owner(s) can decide what drawings, if any, they should take out (BUT, remember, it does not show the CASH available, so the profits may not be available for drawings because they are invested in stocks, equipment or other ASSETS).

You can also use it to be sure that important costs such as raw materials or other items are being controlled properly, that prices are not too low, and that sales are growing according to plan.

The following is an example of a simple Profit and Loss Account:

PROFIT AND LOSS ACCOUNT FOR MONTH XYZ

Sales			500
÷ Costs:
	opening stocks	100
	+ purchases	50
	./.stocks at the end of the period	70
			-----
	= stocks used during the period		80
			-----
Gross margin or gross profit			420
			-----
÷ Other Expenses:
	· wages	100
	· rent	50
	· supplies	20
	· depreciation	50
	· transport	10
	· repayment of interest, taxes	10
			-----
			240
			------
Net Profit			180
			===