The Trading Account is a financial statement that indicates how much Gross Profit has been made through trading.
Gross Profit is an important measure of financial performance in any business, large or small. Good business managers keep a careful scrutiny of Gross Profit as a small change in the percent of Gross Profit can make a large difference to how well the business performs.
Gross Profit is calculated as the difference between Sales and Cost of Sales (the actual cost value of what was sold). The difficulty arises in this calculation with working out the Cost of Sales. Businesses most usually keep a stock of items to be sold, and this stock tends to fluctuate up and down in value. In order to calculate the Cost of Sales and therefy the Gross Profit, it is necessary to construct a Trading Account.
There is a standard format to the Trading Account as follows: (the dollars are just for an example)
|Less Closing Stock||2,000.00
|Cost of Sales||6,500.00||(65%)|
In the above example, the trading account shows that a Gross Profit of $3,500 was made on Sales of $10,000. It is often useful to show the Cost of Sales and Gross Profit as a percentage.
The term cost of sales can be easily defined by the following example:
If a retail business buys a soccer ball that costs $10.00 and sells it for $15.00 then the 'Cost of Sales' is $10.00 and the 'Gross Profit' on that ball is $5.00.
But what if the business opens on 1 January, 2007 and during the course of the year it buys 200 soccer balls at $10.00 (total purchases =$2,000) and sells only 100 balls at $15.00 (total sales = $1,500). The business has paid out $2,000 for soccer balls and received only $1,500 - has it made a loss?
The answer is no! It still has 100 balls left to sell and the correct calculation of profit must show this. In any trading account, there can be no correct calculation of Gross Profit unless changes in stock levels are also counted.
This situation with soccer balls should be written:
|Less Closing Stock||1,000.00
|Cost of Sales||1,000.00||(67%)|
Therefore despite the fact that the business is down $500 in cash it has in fact made a gross profit of $500.
The purpose of the Trading Statement is to work out how much Gross Profit the organisation has made in given period. The Trading Statement forms part of the Profit & Loss A/c.