Profit or Loss & Financial Position (Cambridge (CIE) O Level Accounting)

Profit or Loss

How does a business measure profit or loss?

• An accountant prepares an income statement for a business to show if the business is making a profit or a loss

• The profit or loss is the difference between the total income and the total expenses 

  • A profit is made if the income is higher than the expenses

  • A loss is made if the income is lower than the expenses

Why is it important to measure profit or loss? 

• The information provided by financial statements shows the owner what has happened to the business during a certain period of time

  • This is usually a year

• It can be used to monitor the progress of the business 

  • If a profit is made, the owner is making money on their investment 

  • If a loss is made, the owner might have to make changes to the business

Assets, Liabilities & Capital

How does a business measure its financial position?

• An accountant prepares a statement of financial position to show:

  • Assets

  • Liabilities

  • Capital

What are assets?

• Assets are things owned by the business

  • Premises, inventory, motor vehicles, money in the bank, etc

• Assets also include amounts that are owed to the business by other people or businesses

  • Money owed to the business by credit customers

    • These are called trade receivables

• Current assets are short-term assets that the business intends to liquidate within a year

  • Trade receivables, inventory, money in the bank, etc

• Non-current assets are long-term assets that the business intends to own for more than a year and they are not easily liquated

  • Premises, motor vehicles, etc

What are liabilities? 

• Liabilities are the amounts that the business owes to other people or businesses

  • Bank loans, bank overdraft, etc

  • Money owed to credit suppliers by the business

    • These are called trade payables

• Current liabilities are short-term liabilities which the business intends to pay within a year

  • Trade payables, bank overdraft, etc

• Non-current liabilities are long-term liabilities which the business intends to take longer than a year to repay

  • Bank loans, etc

What is working capital?

• Working capital is the amount of money a business would have left if it converted all of its current assets into cash and paid off its current liabilities

  • Working capital = current assets - current liabilities

• Working capital can be thought of as the capital available for its day-to-day trading activities

What is capital or owner’s equity?

• Capital is any resource provided by the owner to start up the business or keep it going 

  • This is sometimes referred to as owner’s equity

• Capital is often in the form of money

  • However, it may also consist of other assets

    • Such as buildings, furniture, equipment, motor vehicles, goods, etc

• The owner invests capital into their business

  • Technically the business owes these assets to the owner

• If a business makes a profit then its capital increases

• If a business makes a loss then its capital decreases

What are drawings?

• Drawings refer to when an owner takes assets from the business for personal use

  • This could be money, goods, motor vehicles, etc

• If the owner takes drawings from the business then the capital decreases