Financial Statements

deemed likely to arise. The commonest provision is one for bad or doubtful debts. Where there are very many credit customers, and where the total due from them is large, it is reasonable to assume that a small proportion of them will fail to pay. In this case an amount of, say, 2% to 5% of the total of debtors might be written off current profits and held in a 'provision' account. This can be topped up as total debtors rise, or written back to profits as total debtors fall.

`Reserves' are different from provisions. Making a provision is merely being cautious in not taking credit for profits which may not materialise; creating a reserve is an allocation of profits actually made to a special pool - this may be for some specific purpose, such as to meet costs of future new equipment, or just as a cushion for emergencies. In one-man business it is not usually considered necessary to create a 'general reserve', it being sufficient merely to place all undrawn profits into the proprietor's own capital account.

Example

Shown on pages 152-3 are the final accounts of a retail jeweller at the end of his financial year to 30 June 2016. You are required to make an assessment of his progress and comment on the accounts, interpreting them for a layman.

Interpretation

1. Gross profit is the amount by which total sales of goods (in this case) exceeds the cost of those goods. In a manufacturing industry costs would have included direct wages. The first item of expenditure shown in the account is arrived at by taking the value of stock of jewellery at the beginning of the year, adding the costs of goods purchased during the year, and deducting the value of the goods still in stock at the end of the year, valued at cost price. This will give the total cost of all items sold. Deducted from total sales turnover of £1305,305 this indicates a gross trading profit of £113,920. To determine the percentage gross profit (i.e. rate of mark up) one divides the gross profit by the costs of sales (13,924 21,385) and multiplies by 100 to give about 65%.

2. Net profit is the amount of profit left out of gross profit after all expenses have been deducted. The net profit is shown as £17,328. Now, the proprietor appeared to have £1303,181 of his own capital invested in this business at the beginning of the year. Capital costs money, just as labour does. If he had had to borrow this amount of money at, say 15%, he would have had to pay interest on it of almost £15,000 a year. If he is using his own money then he is forfeiting the interest of £15,000 a year he would have received had he invested it in, say, gilt-edged securities. So it appears that his year's work in running this business has provided him with an income in terms of profit of only £12,328 more than he could have


Small Businesses

The same method of preparing, final accounts is also suitable for businesses run by a sole proprietor, although if he is trading in commodities, or is a manufacturer, amounts must be shown for stocks of raw materials and partly finished and finished goods, and also for his purchases of goodwill where a going concern has been acquired by a purchaser at a price that includes an amount in respect of the 'goodwill' built up by the previous owner - in other words with the customer connection. A shop or guest house, for example, often changes hands at a figure above the value of net assets, reflecting the... see: Small Businesses


Refunds, Personal And Business Finance 2017

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