Capital and Profit

What is Capital? Business capital encompasses all the assets and property owned by a firm. There are various types of capital, including fixed capital (assets used continuously in business operations), circulating or floating capital (capital needed regularly for production), liquid capital (cash, debtors, and bank balances), and working capital (excess of current assets over liabilities). […]

What is Capital?

Business capital encompasses all the assets and property owned by a firm. There are various types of capital, including fixed capital (assets used continuously in business operations), circulating or floating capital (capital needed regularly for production), liquid capital (cash, debtors, and bank balances), and working capital (excess of current assets over liabilities).

 

Working capital is crucial as it helps assess the liquidity position of an organization, determines funds available for day-to-day operations, and influences profitability by facilitating stock purchases for sale. It also safeguards against capital entanglement, indicates organizational solvency, and signifies independence from financial reliance on suppliers.

 

Owners’ equity or net worth is the surplus of total assets over liabilities, while loan capital refers to long-term liabilities. Reserve capital is the uncalled part of issued capital, and nominal or authorized capital is the maximum amount a company can raise, as specified in its memorandum of association. Issued capital is the part of authorized capital issued to shareholders, and called-up capital is the portion shareholders have been required to pay.

 

Paid-up capital is the amount shareholders have actually paid, and uncalled capital is the total yet to be called up on the issued capital. Call in arrears represents the difference between called-up capital and paid-up capital, reflecting the unpaid portion. Calls paid in advance refer to money received before calls are made for payment, indicating funds received ahead of schedule.

 

Profit

A business firm’s profit can be categorized as either Gross Profit or Net Profit.

 

Gross Profit

This is determined by subtracting the Cost of Sales from the total sales, also known as Cross Price or markup, which is the amount added to the cost to establish the selling price.

In formula terms: Gross Profit = Sales minus Cost of Sales

It’s crucial to note that Gross Profit alone doesn’t represent the true profit, as other business expenses are incurred. The key metric to assess a business’s success is the NET PROFIT.

 

Net Profit

Net Profit is derived by subtracting business expenses from the Gross Profit. This amount represents the reward for the business owner(s) after accounting for the risks taken. The success of the business is evaluated based on the Net Profit.

 

Expenses encompass various costs like rent, rates, advertising, depreciation, bad debts, electricity bills, wages and salaries, transportation, carriage outwards, insurance, etc.

 

Items In The Trading Profit And Loss Account

  1. Purchases
  2. Sales
  3. Returns inwards
  4. Returns outwards
  5. Carriage inwards
  6. Gross Profit or Gross Loss
  7. Expenses (e.g., rent, wages, insurance, etc.)
  8. Other operating incomes (e.g., discount received, commission received, bad debts recovered, etc.)
  9. Net Profit or Net Loss

 

Turnover

This refers to the total net sales during a specific period, also known as stock-turn, sales turnover, or stock-turnover.

 

Rate of Turnover

This represents the number of times the average stock is sold within a given period, usually a year. It is calculated by dividing the cost of goods sold by the average stock.

Rate of Turnover = Cost of goods sold divided by Average Stock

 

Factors Affecting The Rate of Turnover of A Business

The rate of turnover significantly impacts a trader’s gross profit. Increasing turnover involves considering various factors:

  1. Nature of the product.
  2. Advertisement and Sales Promotion.
  3. Location of the business.
  4. Goodwill or reputation of the seller.
  5. Prices.
  6. Wide variety of products offered for sale.
  7. Reliability and frequency of supply.
  8. Credit facilities.
  9. Application of modern sales techniques (e.g., self-service encouraging impulse buying).
  10. Number of sales outlets or branches of the business.

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