Understanding Accounting Reports.

Transcription

1 Understanding Accounting Reports Whats inside You ll often hear the term management accounts - but how often do you use this information to actually manage your business on a day to day basis? It may well be that you just don t get the information fast enough, in which case you need to improve your bookkeeping efficiency and automation so that you can get reports within a few days of month end.

2 Welcome to Understanding Accounting Reports You ll often hear the term management accounts - but how often do you use this information to actually manage your business on a day to day basis? It may well be that you just don t get the information fast enough, in which case you need to improve your bookkeeping efficiency and automation so that you can get reports within a few days of month end. In order to really make the most of management accounts, you need to understand what they mean and why they exist. This ebook takes a look at the basic principles of accounting, and shows you how to interpret your Profit and Loss, Balance sheet and Trial Balance. 2

3 Basic principles Your accounting data is made up of lots of individual transactions, which in a double entry accounting system means that whenever you add money, you need to give it a reason, and likewise when you remove money, you need to give it a reason. Take a cash sale, for example. You receive $10 into your petty cash, and you need to record a reason, let s say it s Consultancy (selling inventory is a little more complicated). These two lines are recorded in an accounting system as follows: Debit Credit Petty Cash $10.00 Consultancy $10.00 We won t go into the detail of Debits and Credits in this guide, other than to highlight that each double-entry transaction has two sides; at least one Debit and at least one Credit. In any one transaction, the total debits must equal the total credits. All lines in the accounting system have an account code, so in the above example, you d have a code for Petty Cash, and a code for Consultancy. These account codes (sometimes called nominal codes) are separated into different account types, which let us build accounting reports. There are 4 types of account: Assets Liability Capital Revenue Expense What you own, and what you are owed What you owe (loans, supplier credit) Your company equity Records sales made Records purchases made Some systems split these down further into Current assets and Long term assets, and the same for liabilities. Similarly, you may choose to separate your expenses into Purchases relating to sales and Overheads. Assets, Liabilities and Capital are Balance Sheet accounts, which mean that they track what you owe and what you own. Revenue and Expenses are Profit and Loss accounts, since the difference between the two is the profit you make. 3

4 Balance Sheet Remember that only Asset, Liability and Capital accounts appear on a Balance Sheet. The Balance Sheet therefore shows you everything that you consider an asset to the business, which includes: Cash in the bank Inventory Unpaid customer invoices Equipment and property It also includes liabilities, such as: An overdrawn bank account Unpaid supplier invoices Sales Tax or VAT owed Outstanding loans One of the principles of accounting is that Assets - Liabilities = Capital (Equity) Or in other words, if you were to sell all inventory, receive cash for all unpaid customer invoices and pay off all debts, then the value remaining would be the cash value of the business. As long as your Assets are greater than your Liabilities, you are OK. If your Liabilities are greater than your Assets, i.e. you owe more than you are owed, you re in trouble. 4

5 Current assets and current liabilities Current assets are those that you expect to liquidate (turn into cash) within a year. Typically this includes funds in the bank, your inventory and customer debt, but not your plant, machinery or property. Similarly, current liabilities are those that you expect to pay within a year, which includes supplier debt and short term loans, but not a long term loan. The balance between current assets and current liabilities is worth looking at separately from the overall balance sheet figure, since it gives you more of an indication of what s going on at the month-to-month level. A healthy business should have current assets at least twice the value of current liabilities. If not, then you should investigate why. You may be heading into cash flow problems. What affects the Balance Sheet? A profitable business will see the Balance Sheet value go up. In the simplest example, you buy $10.00 inventory and give $10.00 cash to your supplier. The balance is $0.00, since this is one double entry transaction with balancing debits and credits: Pay supplier from bank account - $10.00 Increase inventory levels + $10.00 Note that buying inventory for cash does not affect the number at the bottom of the Balance Sheet, since all you re doing is moving funds between asset accounts; you re trading cash for products. When you come to sell the inventory later, you sell it for $15.00: Customer pays into bank account + $15.00 Decrease inventory levels - $10.00 Balance (in bank account) + $5.00 You ve made $5 profit! Your Balance Sheet total must always match the net profit at the bottom of your Profit and Loss report, which in this case will also be $5. 5

6 Profit and Loss The Profit and Loss report (sometimes called an Income Statement) only includes Revenue and Expense account types. These are the reason codes - like the Consultancy code we saw in the first example. It s pretty straightforward to understand a Profit and Loss; Sales - Expenses = Profit Gross profit and Net profit Most businesses break their expenses down into two further sub-sections; Direct expenses - which are costs incurred in the process of selling goods, such as buying inventory, shipping from suppliers and packaging materials, and Overheads, or fixed costs, which are generally not associated with the volume of sales, such as rent, wages, interest on loans and so on. The Gross profit is the profit you make before the overheads are removed. This figure gives you the profitability of your product range, including the costs of shipping and processing. It might prove insightful to look at this in detail - make sure that your systems are set up to give the right figures in the right sections. The Net profit is the value on the very bottom of the Profit and Loss report, once you have subtracted all the other expenses in your business. Clearly if you re making a negative net profit, you re in trouble! In order to make use of a Profit and Loss report, you need to make sure that your business is structured so that you get accurate information, quickly. An annual Profit and Loss is pretty much useless for business management and decision making, so aim to have your monthly P&L ready by the 10th of the following month at the latest. If you can t manage that, you re probably not running an efficient business. Also try to get as much data as possible into the P&L, so that you can really see what s going on inside your business. Categorize sales and expenses using the right codes. 6

7 Trial Balance The Trial Balance is not really used for management reporting and decision making, but is usually included in a report pack from an accountant so is worth a quick mention. It contains a list of all your account codes, with the current balance. The balance is the sum of all debits and all credits on the account. Since for every transaction, debits must equal credits, and the Trial Balance contains all account codes, the Trial Balance itself must have a total of zero. If not, then something s gone wrong and you need to investigate! The Trial Balance is a snapshot of your entire business in one report. You can use it to create a Profit and Loss or Balance Sheet, if you know which codes are assets, which are liabilities and so on. Because it s a snapshot of the whole business, it can be used to transfer your accounting data between software systems; either when you re changing accounting package, or at the end of the year when you send your figures off to your accountant. Of course if you re using a cloud accounting package, then your accountant can log in and collect it themselves, as well as investigate any anomalies. Related white-papers The 5 Principles of Commerce Acceleration The Commerce Acceleration Journey : Where Are You? Accounting For Inventory United Kingdom First Floor, New Bond House, Bond Street, Bristol, BS2 9AG Phone United States 625 Market Street, 6th Floor, San Francisco, CA 94105, USA Phone