Financial statements

The financial statements of a business, often referred to as the accounts consist of two main documents. The profit and loss account, often referred to as the P & L and the balance sheet which is sometimes abbreviated to B/S.

The financial statements report upon a period of trading for the business.

The P & L account records the sales and expenses during the period. The difference between the two is the net profit for the period.

The balance sheet provides a snapshot of the assets and liabilities on the last day of the reporting period. The net assets are the assets less the liabilities.

The financial statements can be used and indeed may be required for a number of purposes.

• Accounts reporting the annual performance are required by law for businesses which are incorporated, that is trading as companies. These mandatory annual accounts are sometimes referred to as statutory accounts.
• Annual accounts form the basis for calculating the annual tax due from a company.
• Accounts for shorter periods such as monthly or quarterly are typically used to monitor the performance of a company. These are often referred to as management accounts.
• Accounts are published by companies which have their shares on a stock exchange to support the share price and therefore value of their business.
• Accounts can be used to support applications when seeking funding from a bank or investor.

Profit and loss account

The profit and loss account lists revenues followed by expenses. The difference between the total revenue and expenses is the net profit.

Balance sheet

The balance sheet lists the assets and liabilities of the business.

Assets

• Trade debtors
• Prepayments
• Stock
• Fixed Assets
  • Plant & equipment
  • Land & property
  • Fixtures and fittings
• Cash

Liabilities

• Trade creditors
• Accruals
• Bank loans
• Bank overdraft
• Tax owed
  • Corporation Tax
  • VAT
  • PAYE & NI

Double entry bookkeeping

Modern web based accounting systems provide an easy to use intuitive interface suitable for non accountants and accountants. However the systems are still powered by double entry bookkeeping. Invented in Italy in the middle ages, double entry bookkeeping has underpinned the financial records of businesses for over 500 years.

It isn’t necessary to know double entry to use web based systems - but sometimes it can be helpful in understanding the way the system works.

Double entry has a simple principle - each financial transaction is represented by a debit and a credit of matching amounts.

Here is a simple example representing the double entry when a sale is made and then cash is received from the customer:

1. Make a £100 sale and raise invoice

   Dr Debtors	100
   Cr Sales		100

2. Receive £100 cash from the debtor

   Dr Cash	100
   Cr Debtors		100

The effect of these 2 double entries on the financial statements is as follows

P&L

Balance sheet

Dusty books - where accounting terms come from

Until the relatively recent computerisation of accounts the financial records of a business were stored in large books known as ledgers.

The main book was known as the general ledger (G/L) which had a page for each account where a balance was kept. However no book could be big enough to record all the individual transactions of even a medium sized company and only one person could work on the general ledger at once.

Therefore day books were used to record individual sales, purchases and cash for each day. At the end of the day the the day book totals would be calculated and a single total for that day entered against the relevant account in the general ledger.

As well as the overall totals recorded in the general ledger, businesses needed to keep track of all the people who owed them money and who they owed money to. This is not naturally catered for by the double entry system as operated through the general ledger. This is because the general ledger and double entry works on a single trade debtors account for company sales. Therefore it records the total of debts owed to the company, not an analysis of which companies owe the amounts.

To keep track of the debtors a separate ledger called the sales ledger (S/L) was used. This ledger would have one page for each customer. When a sale was entered into the sales day book, it would also be entered into the sales ledger against the correct customer. A regular accounting task was to check that when all the individual customer balances in the sales ledger were added up that agreed to the running total of debtors recorded in the general ledger. This task is known as reconciling the sales ledger.

To keep track of purchases the purchase ledger (P/L) was used, with one page for each supplier. When a purchase was entered into the purchases day book it would also be entered into the purchase ledger in the correct place for that supplier.

Company v sole trader

Businesses generally operate in one of two forms:

• As a limited company
• As a sole trader or partnership

If a business is started and no action is taken to put it into a company then it will default to being a sole trader (or partnership if there is more than one owner).

There are a number of differences between the two structures. The most important is generally considered to be the fact that a limited company structure provides protection for the owners from being liable for business debts. For a sole trader if the business gets into financial difficulties the owner will be personally liable for any debts of the company to suppliers, government or banks. In a limited company structure then the shareholders will not be liable for any loss over and above the share capital they originally put into the business.

Reporting schedule

Accounting software

When selecting accounting software it is worth ensuring that the software has settings so that the features provided are tailored towards your business structure. For instance, Clear Books, the leading online accounting software, supports both legal structures.

On setting up a new company the organisation type such as limited company, sole trader or partnership is entered.

If the type is company then features supporting directors, shareholders, dividends and corporation tax are enabled. If sole trader or partnership is selected then drawings are enabled and the above features are not shown.

VAT

VAT reporting requirements mean that most VAT registered businesses will submit their VAT return every quarter. This is the time when small business owners will make sure that their accounts are up to date and their paperwork in order. With everything on the accounting system then reports are generated and the total VAT due calculated. Businesses have until the 7th of the following month to submit their return and make their payment. Some accounting software (Clear Books is a good example) help business owners by automating the process of submitting the VAT returns electronically.

YE accounts & tax

All businesses will at some time after their year end reach for their accounting software to produce their annual accounts. The annual accounts, consisting of a P & L and a balance sheet will form the basis for statutory accounts which companies must submit to Companies House. For all businesses the accounts will show the annual profit, which will be the starting point for calculating the tax liability.