Creating a P&L Account and Cash Flow Statement
In this lesson, you’re expected to learn:
– how to prepare and use a profit & loss statement
– how to prepare and use a cash flow statement
– how to interpret a cash flow statement
Profit & Loss as a List
As we know, a P&L merely shows how the retained profit changes over a period of time.
Using the example of Sarah’s company that we referred to earlier, we can see in the table below which entries affected Company X’s retained profit.
The net effect on retained profit of all nine entries is £5,000. However, this P&L list does not provide detailed information of the transactions.
• We then take all the operating expenses and group them into categories. In this case, the operating expense categories are ‘Selling & Distribution’ and ‘Administration’.
• Operating profit is the profit after these operating expenses, which is equal to £13,000.
• After deducting a corporation tax of £4,000, this leaves a Profit After Tax (‘PAT’) of £8,000, which is due to the shareholders.
• Some of this is paid out as dividends (£3,000) to shareholders. So what is then left (£5,000) is the retained profit.
• Capital expenditure includes all buying and selling of fixed assets that enable the operating activities to take place.
• Returns on investments and servicing of finance: means the interest paid on loans and any dividends or interest received on investments or cash that the company has on deposit.
• Equity dividends paid: the dividends paid out to shareholders
• Financing consists of all the transactions relating to the raising of funds to operate the business.
Presenting a cash flow statement in this way makes it easy to understand where the cash in the business has come from and gone to.
• With most businesses, profit and cash flow are not the same at any particular time (day, month or year).
• Total profit and total cash flow will be the same in the long run.
We’ll now look at each of these adjustments.
Depreciation affects operating profit but it does not affect cash.
2) Trade Debtors
When sales are made on credit, not all of this money is collected from customers.
At the end of the year, a company typically has some stock that it has not sold – this is treated as an asset and not included in the calculation of operating profit for the year. The effect of this stock is to make cash flow lower than operating profit. Thus an adjustment on the cash flow statement is necessary.
Similar to stock, cash has been paid out which is not included as an expense in the calculation of the operating profit. This will tend to make cash flow lower than operating profit and an adjustment needs to be made.
5) Trade Creditors & Accruals
Some of the expenses considered in calculating operating profit and some of the stock at the end of the year have not actually been paid for. However, the cash flow statement assumes that they have. We must therefore adjust the cash flow upwards to take account of this.
At the start of the year, most companies will have some debtors left over from the previous year – these debtors will be collected during the current year. Thus, you have to allow for the cash you collect from these debtors in your cash flow calculation.
Assume that you’ve been running a company for the last few years. Your sales for this year are £100,000 and your expenses are £80,000, giving you an operating profit of £20,000. If all your sales and expenses are paid in cash at the time, your cash flow must also be £20,000.
Now, let’s say that last year some of your customers did not pay in cash so that at the end of the year (i.e. the beginning of this year) you were owed £15,000. Those customers paid during the current year so you end up receiving that extra amount apart from the cash received from this year’s sales.
Thus, your cash flow for this year would be:
£20,000 (operating profit) + £15,000 (last year’s debtors)