Incomplete records: statements of affairs, mark-up and margin

Last time

Before we start: last time, in Clubs, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

When the books are missing

Many small traders do not keep full double-entry records. They may have only bank statements, invoices and a list of what they own. Accountants can still work out profit, and fill in missing figures, using a statement of affairs and mark-up or margin.

The statement of affairs

A statement of affairs lists the assets and liabilities of a business on a date, to find its capital. Capital equals assets minus liabilities, just like the accounting equation. One is prepared at the start of the year and one at the end.

Profit from capital

Capital changes because of profit, drawings and new capital. So profit can be found from the change in capital. Profit equals closing capital, minus opening capital, plus drawings, minus any new capital introduced. Opening capital 20,000, closing 26,000, drawings 5,000: profit is 26,000 minus 20,000 plus 5,000, which is 11,000.

Why add back drawings?

Drawings reduced closing capital, but they are not a business loss. So they are added back to find the true profit. New capital raised closing capital, but it was not earned. So it is taken away. What is left is the increase earned by trading: the profit.

Mark-up

Mark-up is gross profit as a percentage of cost price. An item costing 80 dollars sold for 100 has a gross profit of 20. Mark-up is 20 divided by 80: 25 per cent. Mark-up uses cost as the base.

Margin

Margin is gross profit as a percentage of selling price. For the same item, margin is 20 divided by 100: 20 per cent. Margin uses selling price as the base, so it is always smaller than the mark-up for the same item.

Mark-up and margin

A 25 per cent mark-up is the same as a 20 per cent margin. Learn the pairs.

Finding missing figures

If you know cost of sales and the mark-up, you can find sales: sales equal cost of sales plus the mark-up on it. If you know sales and the margin, gross profit is sales times the margin. Missing purchases or sales can also be found from a control account, or a reconstructed cash book.

Reconstructing accounts

Credit sales can be found from a sales ledger control account: the missing figure that makes it balance. Credit purchases from a purchases ledger control account, in the same way. Then the income statement can be prepared as usual.

Mistakes that lose marks

Mistake one: forgetting to add back drawings when finding profit from capital. Mistake two: using selling price as the base for mark-up. Mistake three: treating new capital as profit. The fix: the formula, and the right base.

The full-marks tip

The full-marks tip: find profit as closing capital minus opening capital, plus drawings, minus new capital. Mark-up divides by cost; margin divides by selling price.

On one card

So, on one card: incomplete records. Keep it for revision.