216 CHAPTER 9 GETTING TO NET PROFIT
Other income and expenditure
We are not quite finished. There is a small matter of other income and expenditure to con-
sider. There are four categories.
1 Contingency – an allowance for unexpected costs.
2 Investment income – primarily income on shares in other companies.
3 Interest – received on bank deposits and paid to bank.
4 Taxation.
WHY INCLUDE THEM?
The box opposite shows how they build up in the profit and loss account. You can also
look back at Figure 9.7 to see profit before contingency. Some people do not bother to
show this line. I think that it helps when you come to monitor spending against budgets
for the following reasons.
Contingency
You cannot predict the future with certainty. The contingency reserve provides a margin
for error. It is here so that you can legitimately inflate cash flow slightly – and spend more
than expected without exceeding the budget figure for profit after contingencies. You can
make the contingency a flat amount, or relate it to some other figures – such as 10% of
total operating costs. It is an entry that you include for planning and budgeting purposes.
It disappears as time passes, because it is either reallocated to costs or is unused. Watch
out for a spending binge on trivia at the end of the year if the unused contingency is not
carefully controlled.
Investment income
If you hold share capital or other investments in other businesses, you should be able
to estimate future income from these quite easily. You know what interest or dividend
payouts to expect. Where you have majority interests, you will instead consolidate the
accounts to show the combined profit and loss for the group.
Interest
This is easy. It will fall out of your cash flow projections, which are discussed in Chapter 10.
OTHER INCOME AND EXPENDITURE 217
Taxation
This can be more of a minefield, but it is not impassable. It is possibly one of the areas
where you get greatest value from paying professional advisers to save you money. Taxes
may not relate directly to net profits, because of the effects of timing and differences
between management accounting and income tax accounting for items such as depre-
ciation. If you operate in a difficult tax regime or have a complex company situation, take
advice. If you have to make your own estimates, play it safe and make an estimate on the
high side. Remember that basically you do not pay taxes if you are not making money –
and if you are profitable, well, you do not worry so much.
It all depends what you mean by profit
Getting to the bottom line in a profit and loss account
Sales
= Less Cost of sales
= Gross profit
= Less Operating costs
= Operating profit before contingency
= Less Contingency
= Operating profit with contingency (projected)
= Add back unused contingency during the period
= Operating profit (actual)
= Less Investment income
= Profit before interest and taxation
= Add Interest received on bank deposits
= Less Interest paid to bank
= Profit before taxation
= Less Taxation
= Net profit available for appropriation
The real bottom line. Profits for:
– provisions that cannot be taken before tax (a threatened legal action perhaps)
– distribution to shareholders (dividends)
– ploughing back into the business (retained earning)
– or donating to good causes.
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