Key Financial Concepts: Profit, Loss, Costs

Key Financial Concepts

• Profit is the financial gain when a business's total revenue exceeds its total costs.
• Loss happens when a business's total costs are more than its total revenue.
• Revenue (Sales/Income) refers to the money a business makes from selling its goods or services.
• Costs are the total monetary amounts spent by a business to produce goods or services.
• Fixed Costs are those expenses that remain constant, irrespective of the production level, for example, rent, salaries, and insurance.
• Variable Costs fluctuate with the production levels, like raw materials, electricity, and wages.
• Expenses are the costs a business incurs while operating, including marketing, transportation, and administrative costs.

Cost Price (CP) & Selling Price (SP)

• Cost Price indicates the amount a seller pays to acquire or produce a product before selling.
• Selling Price refers to the amount a customer pays to purchase a product from a seller.

Understanding Loan Terms

• A loan term is an agreed duration between a borrower and lender.
• The loan term specifies how long the borrower has to repay the loan.
• Loan terms can be short-term lasting a few months.
• Loan terms can be long-term, spanning several years or even decades.
• The specific term depends on the type of loan, such as a personal loan, mortgage, or auto loan.

Calculating Profit

• Calculated using the formula: Profit = Revenue - Total Costs
• Example: If a business has ₱50,000 in revenue and ₱30,000 in costs, the profit equates to ₱20,000.

Net Price and Trade Discounts

• Net price represents the final price after all applicable discounts have been applied.
• Trade discount is a reduction in price offered by a seller to a buyer.
• Trade discounts are generally based on bulk purchases or business agreements.
• List price is the original price of a product prior to any discounts or deductions.

Formulas for Price Calculations

• Net Price = List Price - (List Price * Trade Discount Rate)
• Trade Discount = List Price * Trade Discount Rate
• List Price = Net Price / (1 - Trade Discount Rate)
• Trade Discount Rate = 1 - (Net Price / List Price)

Trade Discount Example

• A furniture store buys a sofa with a list price of ₱5,000 with a trade discount of 20%.
• Trade Discount = List Price × Trade Discount Rate = ₱5,000 × 0.20 = ₱1,000
• Net Price = List Price - (List Price × Trade Discount Rate) = ₱5,000 - ₱1,000 = ₱4,000

Financial Statement Types

• Balance Sheet: Provides a snapshot of a company's assets, liabilities, and equity at a specific point in time.
• Statement of Cash Flows: Details the movement of cash both into and out of a company over a period.
• Income Statement: Summarizes a company's financial performance, including revenues, expenses, and profit or loss, over a period.
• Statement of Retained Earnings: Shows how much of the company's profit is kept for reinvestment after dividends are paid.

Closing Entries in Accounting

• Closing entries serve to transfer balances from temporary accounts, like revenues, expenses, and drawings, to a permanent owner's capital account.

Types of Companies

• Finance Companies: Offer loans, credit, and financial services.
• Leasing Companies: Rent assets like equipment, vehicles, and property.
• Trade Companies: Engage in buying/selling goods and services.
• Trade Debtors: Customers that owe a business money for purchased goods or services on credit.

Types of Finances

• Internal Finance: Funds generated from the business's operations. Includes retained earnings like profits reinvested back into the business, and revenue from asset disposal from selling surplus/unused assets.
• External Finance: Capital sourced from outside of the business, such as with bank loans that must be repaid with interest.

Important Financial Terms

• Break-even point reflects the sales level at which total revenue equals total costs, resulting in neither profit nor loss.
• The Insolvency point refers to when a business is unable to meet its debt obligations.
• Start-up stage refers to the initial phase of a business where costs are high and sales are low.
• Profit point is an informal term describing the level of sales at which a business starts to make a profit, going beyond the break-even point.

Types of Capital

• Equity Capital: Money raised from owners/shareholders by issuing shares (common or preferred stock) and retaining profits.
• Debt Capital: Funds borrowed from external sources like banks or by issuing bonds, repaid with interest, and does not dilute ownership.
• Working Capital: The difference between current assets and liabilities. Represents funds for day-to-day operations like inventory and short-term obligations.
• Fixed Capital: Funds invested in physical assets used long-term like machinery, equipment, and property.
• Venture Capital: Investment funds for start-ups or small businesses with high growth potential.

Financial Statement Components

• A financial statement is a formal record that summarizes a company's financial activities and position over a specific period.
• Adjusting entries ensure financial statements adhere to the accrual basis of accounting at the end of each accounting period.
• Recording Accruals: Adjusting revenues and expenses earned or incurred but not yet recorded.
• Recognizing Deferrals: Allocating prepaid expenses and unearned revenues to the correct periods.
• Updating Depreciation: Recording depreciation expense for long-term assets.
• Correcting Errors: Fixing mistakes in financial records.

Financial Report/Statement Details

• Income Statement measures a company's performance over a period by detailing revenues, expenses, and net income/loss.
• Balance Sheet displays a company's financial position at a specific time by listing assets, liabilities, and equity without measuring performance over time.
• Trial Balance lists ending balances of all ledger accounts to ensure total debits equal total credits and is used during accounting.

Simple Interest

• Simple interest is the extra amount earned or paid on a principal amount over a period at a fixed rate.
• Formula: SI = P × r × t, where:
  • SI = Simple Interest, P = Principal, r = Annual interest rate (decimal), t = Time in years

Simple Interest Examples

• Depositing ₱10,000 at 5% annually for 3 years yields simple interest: SI = 10,000 × 0.05 × 3 = ₱1,500
• Investing ₱12,000 at 6% annually for 4 years results in simple interest: SI = 12,000 × 0.06 × 4 = ₱2,880
• The time period for a ₱15,000 loan charged ₱3,000 simple interest at 5% annually is: T = 3,000 / (15,000 × 0.05) = 4 years
• Earning ₱2,500 simple interest over 5 years at 4% annually requires principal: P = 2,500 / (5 × 0.04) = ₱12,500
• Finding rate with the formula: R = I / (P × T)

Additional simple interest examples

• Investing ₱8,000 at 7% in the bank annually for 3 years results in simple interest earned: ₱1,680
• Finding the time period for a loan of ₱25,000 charged ₱5,000 in simple interest at 4% annually is 5 years
• Earning ₱3,600 in simple interest over 6 years at an annual rate of 6% requires a principal amount invested: ₱10,000
• Finding the interest rate for ₱9,000 in simple interest earned from an investment of ₱30,000 for 5 years: 6%

Assets, Liabilities & Equity

• Assets are business/individual possessions providing value and income potential, where Assets = Liabilities + Equity.
• Liabilities represent business/individual obligations where Liabilities = Assets - Equity.
• Equity shows owner's stake in company after liabilities are covered, also seen as net worth, where Equity = Assets - Liabilities.
• For example, a company with ₱950,000 assets and ₱400,000 liabilities has equity of ₱550,000.

Cost of Goods Sold (COGS)

• COGS includes direct costs for producing or purchasing goods sold by a business during a period. It includes materials, labor, and purchases, and does not include marketing or rent.
• The formula is: COGS = Beginning Inventory + Purchases - Ending Inventory.
• For example, a bakery starting with ₱5,000 in ingredients, buying ₱3,000 more, and ending with ₱2,000 has COGS = ₱6,000.

Markup, Markdown & Selling Price

• Markup refers to the amount added to the cost price determining a product's selling price.
• Markdown is a deduction in the original price designed to attract customers or clear inventory.
• Selling price represents the final price paid post-markup or markdown.

Relevant formulas

• Markup = Selling Price - Cost Price.
• Markdown = Original Price - New Price.
• Selling Price = Cost Price + Markup; or Selling Price = Original Price - Markdown.
• Markup Percentage = (Markup Price / Cost Price) × 100%; or Markdown Percentage = (Markdown Price / Cost Price) × 100%.

Markup & Markdown Examples

• A jacket originally priced at ₱1,000 reduced to ₱800 has a markdown rate computed as (markdown price/cost) x 100% which means 0.2 x 100% equaling 20%
• The markup percentage for a store buying a bag for ₱800 and selling for ₱1,200 is 50%.
• The markup rate for a table being marked up 20% after it was bought for ₱1,500 can be solved by multiplying the cost price with the percentage and then adding it, 1,500 + (20% x 1,500) = ₱1,800.

Inventory Shrinkage

• Inventory shrinkage describes losses when the actual stock is less than recorded due to theft, damage, fraud or record errors.
• Shrinkage = Recorded Inventory - Actual Inventory.
• Calculated as: Shrinkage Percentage = (Shrinkage/Recorded Inventory) x 100.
• A warehouse with ₱500,000 recorded inventory but only ₱480,000 actual stock gives a shrinkage of (20,000/500,000) x 100 equalling 4%.

Break-Even Point

• The break-even point (BEP) refers to the sales level needed to equate revenues and total costs, resulting in neither profit nor loss, which helps businesses determine sold units to cover expenses.

BEP Formula

• BEP (units) = Fixed Costs / (Selling Price per Unit – Variable Cost per Unit)
• If Fixed costs = ₱60,000, the selling price is ₱500, and the variable cost is ₱300 then BEP(Units) = 300 Units

Net Income Explained

• Net income (profit or bottom line) is the amount remaining after deducting all expenses from a company's revenue.
• Calculated as: Net Income = Total Revenue – Total Expenses.
• Earning ₱500,00 in revenue with ₱350,000 in expenses results in net income: ₱150,000
• A company with a profit margin of 30% with ₱750,000 in total revenue is ₱225,000.

Profit Percentage

• Profit Percentage is a metric determining business profitability relative to cost/selling price.

Calculating Profit Percentage

• Profit Percentage = (Profit / Cost Price) × 100 when profit's based on the original cost.
• A bicycle bought for ₱6,000 and sold for ₱7,500 has a profit where Profit = Selling Price − Cost Price = 7,500 - 6,000. Resulting in ₱1,500, calculated as (₱1,500 / ₱6,000) × 100% equaling 25%.

Calculating Profit Margin

• A business has a ₱120,000 Net Income and ₱400,000 in total revenue with a profit margin that is 30%

Examples

• Calculate markup where a smartphone costs ₱30,000, and the seller makes a 20% profit is ₱36,000
• Calculating selling by having a loss of 10%, and a ₱300 book results in solving the profit to a Cost Price Loss of ₱270
• For a bag bought that cost ₱1,200 is now being sold for ₱1,080 results in a 10% percentage loss

Types of tax

• Income Tax: Levy based on earnings.
• Property Tax: Levy based on ownership.
• Corporate Tax: Paid to the government by businesses.
• Value-Added Tax: Taxes added to goods and services.
• Excise Tax: Levy based on fuel, alcohol and Tobacco.

Depreciation

• Depreciation refers to decreasing value in wear and tear. This helps Businesses reduce costs over usage.
• A machine has a book value of ₱120,000 which depreciates by 15% per year.

Revolving and Installment Credit

• Revolving Credit: Unlimited access with repeated payments.
• Installment Credit: Credit with a fixed amount like payments and mortgages.
• Trade Credit is between business to business.
• Service Credit refers to work being done with payment with pension, retirement, or leave privileges.