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Business Book-Keeping Part 4

By Paul Michael
27th October, 2009

 
Financial Reporting for Business

We will use the transactions that we discussed in Part 3.
 
There are three main reports that are in demand when it comes to business financial reporting: Cashflow Statement, Balance Sheet and a Profit & Loss Report.
 
The Cashflow Statement shows the in-flows and out-flows of cash in the business. For most businesses it is likely to be linked to the bank account. This is by far the most important report because even the most profitable businesses cannot be in business without cash. The cashflow statement is looking primarily at the Current Assets ledger where we normally find one or more Bank accounts. Any transaction that debits or credits our Bank accounts should appear on the cashflow statement to arrive at a balance at the end of each reporting period. There are many variations of a cashflow statement, but this simple version serves well:
 
Cashflow to 31/01/2009
 

Opening Balance
0
 
 
Cash In-Flows
 
 
 
31/01/20??
Rent Received
600
 
 
Total
600
 
Cash Out-flows
 
 
 
24/01/20??
ACE Plumbing
 
-120
31/01/20??
Mortgage Intst
 
-10
31/01/20??
Mortgage Princ
 
-200
31/01/20??
Drawings
 
-100
 
Total
 
-430
Closing Balance
170
 
 

 
We would reconcile these figures back to our actual bank statement to check our figures and also to determine any outstanding payments. For example, although we have paid the plumber, has he deposited our cheque yet? If not, how will this affect our cashflow next month if we have other payment demands?
 
This statement also provides us with the ‘Cash Book’ value. In days of old, any cash received or paid out would be entered into a Cash Book ledger, but the term is often used is businesses today.
 
Next up is the Balance Sheet, which is a snapshot in time of the values of our Liabilities and Assets, which we now know should always be in balance. The Balance Sheet tells us who owes us money (our Debtors) and who we owe money to (our Creditors). It tells us what our assets are worth and we can analyse both short and long term assets and liabilities. As a snapshot, it is usual to compare the current Balance Sheet with a prior Balance Sheet, perhaps from the previous year.
 
 
 

Ledger
Account
Dr
Cr
Fixed Assets
Property
100,00
 
Current Assets
Rent
600
 
 
ACE Plumbers
-120
 
 
Mortgage Interest
-10
 
 
Mortgage Principal
-200
 
 
Drawings
-100
 
Long Term Liabilities
Mortgage
 
-50,000
 
Mortgage Principal
 
200
Short Term Liabilities
Trade Creditors
 
-120
 
Trade Creditors
 
120
Owner’s Equity
Investment
 
-50,000
 
Rent
 
-600
 
ACE Plumbers
 
120
 
Mortgage Interest
 
10
 
Drawings
 
100
Balance
 
100,170
-100,170

In this example of a simple balance sheet the transactions are included to show how they are related to the main elements of the balance sheet. For example, Rent increases both the Bank (Current Assets) and Revenue, which is a sub-ledger of Owner’s Equity. It is normal to summarise the account values into their sub-ledger categories.

We can also do some nifty ratios with Balance Sheets. For example, the Current Test determines if our Current Assets will cover our Current (Short-Term) Liabilities. An Acid Test is the same, less any stock value in the Current Assets. 

The Profit & Loss (P&L) Report shows if the business has made a profit or a loss over the reporting period. It is usual to take the Revenue or Sales and then to subtract the Cost of Sales to arrive at the Gross Profits. Cost of Sales is calculated, unless some form of stock control system is used, from stock accounts within the Current Assets ledger. To the opening stock balance, add the stock expenditure over the period, and then subtract the current stock value (from a stock-take).

From the Gross Profit, which is sometimes known as the Contribution, we subtract our Expenses, either as a total or, more beneficially, by expense account. This yields our Net Profit or Loss. Finally we subtract any Drawings, which yields any retained earnings.

 

 

Dr

Cr

Revenue

Rent

 

-600

Cost of Sales

 

0

 

 

 

 

 

Gross Profit

 

 

-600

 

 

 

 

Expenses

ACE Plumbers

120

 

 

Mortgage Interest

10

 

 

Mortgage Principal

200

 

Net Profit/Loss

 

 

-270

 

 

 

 

Drawings

Drawings

100

 

 

 

 

 

Retained Earnings

 

 

-170

 

This is written using the Debit and Credit rules and can look quite quirky when a negative balance is actually a good thing. We would normally inverse these figures so they make sense to a wider reading audience. However, we can see that we are in profit by 270 and we have drawn down 100 from this, so there remains 170 earnings in the business.

Tax

Tax is payable upon the ‘taxable profits’ of a business. The ‘taxable profits’ are not usually equal to P&L reported profits. An example is an Expense known as Depreciation, where the worth of your assets are depreciated as they wear out, or sometimes might appreciate as would property in a buoyant market. Depreciation is deducted as an expense from Gross Profits. However, Depreciation is not allowable under UK tax rules. There is, however, an allowance for Capital Expenditure and there are specific rules regarding what types of capital are allowable under this heading.

Having both a Balance Sheet and P&L Report categorised down to the account level enables us to piece together the required reports for tax purposes.

Unless you know a thing or two about taxation, or you are willing to wade through and understand tax matters on the HMRC website, it might be best to hand this aspect over to your accountant. Accountants often save you money based upon their knowledge of the tax system. If you undertake your own book-keeping, you should be able to beat the accountant’s prices down because they are not having to prepare your accounts, as they would if you handed over a box of receipts.

Further Reading and Help

There are plenty of books and publications available on this subject. So many in fact, that it would be inappropriate to recommend any one in particular. There is also plenty of web help, and this site is a good place to start: http://www.dwmbeancounter.com/tutorial/Tutorial.html

  

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