Capital and Profits of a Business
Financial Statement of a Business
- Balance Sheet: Shows the financial position of a business at a certain point in time.
- Profit and loss account: Operational results of a business during a certain period in time.
- It gives the summary of assets, liabilities and capital of a business.
- Shows where sources of finance have been spent.
Sources of Finance = Allocation of Finance
Capital + Liabilities = Assets
- Resources of the business required for its operations.
- Fixed assets are those assets which will remain in use of business for more than one year. These assets are usually expensive and valuable. Examples: Land, Building, Machines, Furniture, Equipment and Vehicles.
- Current assets are those assets which will be used by the business for its operations within one year. Example: Stock of raw materials, Debtors (amount of sales on credit), bank balance and cash in hand.
- Represents the money that has come into business from outsiders, other than investment from the owner.
- Long Term Liabilities are those liabilities which are to be repaid after one year.
- Current Liabilities are those amounts that the business is liable to pay in next one year. Example: Creditor (money the business as to pay against credit purchases of raw material).
1. Capital Owned/Equity Capital/Net worth of Business
Amount of money that business owes to its owner at a certain point in time.
Capital Owned = Assets - Liabilities
Capital Owner = Capital at the start + Profit at the end - drawings
2. Fixed Capital
Amount of money that business has issued to acquire fixed assets at a certain point in time
3. Circulating Capital/Floating Capital
Amount of money that business has tied up with current assets at a certain point in time.
4. Capital Employed
It is the wealth actually used in the firm to earn income
Capital Employed = Capital Owned + Liabilities - Debtors
Capital Employed = Net Assets - Debtors
5. Capital Invested
Amount of money brought into business by the owner.
Capital Invested = Capital at begining - Drawings
6. Working Capital
It is the money used by the business to finance routine expenses.
Working Capital= Current Assets- Current Liabilities
7. Working Capital Ratio
Ratio show the extent of business financial stability
Working Capital Ratio = Current Assets / Current Liabilities
Working Capital should ideally between 1 and 2.
8. Liquid Capital
Liquidity is the ease with which one can fully convert its resources into legal tender. Legal tender is the medium of exchange which is balanced by the law of country.
It is a part of current assets which are in form of cash, bank balance and debtors.
Liquid Capital = Current Assets - Stock
9. Liquid Ratio/Acid Test Ratio
Shows the solvency position of a business. Solvency means being able to meet current liabilities.
Liquid Ratio = [Current Assets - Stock] / Current Liabilities
Stock is excluded because stock is difficult to convert to cash very quickly.
Profit and Loss
1. Turnover/Net Sales
It is the total value of goods sold in the year.
Turnover = Goods sold - Goods returned
2. Cost of Goods Sold
It is the cost of goods that have been sold.
Cost of Goods Sold = Opening Stock + Net Purchases - Closing Stock
3. Gross Profit
Overall profit on trading
Gross Profit = Net Sales- Cost of Goods Sold
4. Operating Expenses
Indirect expenses/Overheads/Oncost are fixed costs for example rentals, electricity bills and advertising costs.
Direct expenses are varying costs for example salaries and wages.
5. Net Profit
Final profit of the business after deducting all the expenses.
Net profit = Gross profit - Operating expences
Difference between buying and selling price ≠ Gross profit.
7. Percentage Markup
Percentage Markup = [Cost of Goods Sold / Total Sales] x 100
Profit out of a unit sale.
9. Gross Profit Percentage
Gross Profit Percentage = [Gross Profit / Turnover] x 100
10. Net Profit Percentage
Net Profit Percentage = [Net Profit / Turnover] x 100
11. Rate of Turnover
Rate of Stockturn = Cost of Goods Sold / Average Stock at Cost Price
12. Average Stock
Average Stock = [Opening Stock + Closing Stock] / 2
How Working Capital can be improved
- Injection of fresh equity (owners money).
- Long term loans.
- Sale of surplus fixed assets.
- More sales.