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Understanding Your Accounts
Your accounts are prepared principally for you to understand how your business is performing and its current state of health. They are also produced to satisfy the needs of the Inland Revenue, your bank manager, and others. These, often conflicting, requirements may result in accounts which are not easily understood by the lay user. These notes are our attempt to make the accounts of sole traders and partnerships more user friendly. If the notes do not cover "everything you wanted to know about your accounts but were afraid to ask" please contact any of our staff who will be happy to help.
Profit and Loss Account
(or Income and Expenditure Account)
This shows all the income received and expenditure incurred by your business during the financial year and whether your efforts have been rewarded by a profit or loss. It represents your "performance".
Trading income, or sales, will be shown separately from other types of income. From the sales we deduct the cost of sales. If you are a retailer this will simply be the cost of buying the merchandise which you have sold. If you are a manufacturer then this will be the cost of materials, labour, and other expenses incurred directly in making the products you sell. Whatever the business, cost of sales is made up of those costs incurred directly to make the product or provide the service which you sell. Sales minus cost of sales equals your gross profit.
The gross profit expressed as a percentage of sales tells you how much, on average, your business is making on each sale and can usefully be compared with the percentage for last year or with that achieved by your competitors. Comparative figures for last year are provided alongside each entry in your accounts.
The gross profit has to be enough to cover all your expenses and leave enough profit for you to live on. Not only do you have to make a profit on each item you sell, but you also have to sell enough of them to cover your expenses and make a decent profit. Expenses are analysed into as many categories as is necessary to enable you to control them and to make it possible to complete the Inland Revenue returns. The net profit is your reward and is the basis for computing your tax bill.
Balance Sheet
This shows your business's position at the end of the financial period, usually the year end. It is a snapshot of the business at an instant in time. It shows one measure of the worth of the business, the amount that would be left had you stopped trading at that moment, sold all the property, fixtures, vehicles, stock etc, collected customer balances, paid all suppliers and other creditors then emptied the bank account. In theory you would be left with the balance sheet total in cash.
We say in theory because the balance sheet only contains estimates of the market value of each asset and it is unlikely that precisely these amounts would be realised in a disposal. For accounting purposes we assume that assets reduce in value at a consistent rate called depreciation. The Revenue has its own rates of depreciation for most assets and this will not normally coincide with the market value.
The worth of the business is balanced by, or financed by, the capital you have introduced into the business plus the profit made each year and less the amount you have withdrawn for personal use each year (your drawings).
Drawings are the amount you withdraw from the business for your own personal use; you may think of this as your wages but it will not form the basis of your tax (see above). You may withdraw from the business as little or as much as you want but if you withdraw more than you make in profit, or if you make a continuing loss, your business will become insolvent and the balance will become a negative figure (represented by brack
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