Accounts Made Easy

Overview
Information is the key to understanding the successes and failures of your business and the key to making appropriate business decisions to avoid future failures and capitalise on successes.

A proper accounting system is not a luxury that small businesses can do without, it is a necessity that they cannot afford to be without.

What your business needs
The type of information that even the smallest business should generate includes:

• A regularly revised business plan and financial forecasts

• Books written up on a daily or weekly basis

• Accounts produced on a monthly basis

• Regular (i.e. at least monthly) reconciliations between your cash book and the bank statements

• A monitor of actual trading results against those predicted in the forecasts

• Regularly revised cash-flow forecasts covering at least the next three months, and

• A monitor of the cost and profitability of each of your contracts

This guide
This guide is designed to help you take the first steps in accounting. It explains what accounts are, why you need them and what they mean. It also explains the minimum accounting records that your business will need to keep. 

This guide has been written for the managers and owners of small businesses. For simplicity the examples given are based on the accounts of a small limited company. However the principles illustrated apply equally well for sole traders.  

Introduction
Understanding accountancy and finance is like driving a car:

• It fills most people with dread and fear

• But once they've had a bit of experience it becomes second nature and they wonder what all the fuss was about. They probably even start to do it without thinking (just as drivers instinctively change gears etc).

Who is interested?
Many people will be interested in your accounts. For example:

• Your bank manager - since they will help him to decide whether to lend you money

• Your building society - they will need to see your accounts before they will give you a new mortgage

• The taxman - he needs to see your accounts to work out how much tax you owe

• Your customers - new customers may look at your accounts to decide whether you are a successful  and reliable contractor

• Your suppliers - who might use your accounts to decide whether you are a good credit risk.

But most of all, you should be interested in your own accounts.

Who are accountants?
Unfortunately there is nothing to stop anybody calling themselves an accountant. This means that it is vitally important to understand the three main types of accountants.

• Bookkeepers - Their role is largely to "keep the score" by recording the financial effects of what a company has done. They are usually the best people to do routine accounting work.

• Qualified accountants - These are experienced professionals who have undergone rigorous training and passed extremely difficult exams. There are a number of leading qualifications - but if you look for the letters ACA, FCA, ACMA, FCMA, ACCA or FCCA after the accountant's name you should not go too far wrong. Qualified accountants are best at dealing with the non-routine aspects of your business eg helping you to increase your profits, produce your statutory accounts and pay less tax.

• Unqualified accountants - There are also many unqualified "accountants". Before deciding to use the services of one, we suggest you ask yourself: "Would I put the health of my family in the hands of an unqualified doctor?" If the answer is no, why consider putting the health of your business in the hands of an unqualified accountant? Don't be afraid to ask what qualifications and  expertise an accountant has - and if you have any doubts, try somebody else.

A definition of accountancy 
Accountancy is about identifying and recording, analysing and explaining, the financial implications of business transactions and decisions to enable businessmen to understand the performance of their businesses, and to help them make decisions and take actions which assist in achieving the objectives of the business.

But don't worry, as we will explain over the next few pages, it's actually really rather simple!

Types of accounts
Just as there are several different types of accountants, there are also many different types of accounts. However they can be grouped under two main headings:

• Financial accounts - for limited companies these are sometimes also known as statutory accounts; and

• Management accounts

Financial accounts
These are compulsory for companies, and must be sent every year to the shareholders in your company and to Companies House. In addition:

• They must follow a standard set of rules and conventions, and show what went on during the financial year; and

• They are mainly used by people outside your business - eg bankers, customers, suppliers and, of course, the taxman.

Sole traders and partnerships must also produce financial accounts - although they do not need to be sent to Companies House and there are not so many rules governing how they must be set out and what they must contain.

Management accounts
This type of accounts are essential for well-run businesses, but are not strictly required by law. As their name suggests, management accounts are mainly used by management. In fact it is very rare for them to be shown to anybody outside the business - and businesses cannot usually be forced to show their management accounts to anyone other than their auditors and (in exceptional cases) the taxman.

There are no rules that say what management accounts must look like - it is up to each business to decide what format will best help it to understand what is going on, control the business and make better decisions

Management accounts often predict the future as well as keep track of the past i.e. they usually include forecasts of what is going to happen tomorrow as well as recording what happened yesterday. In contrast, financial accounts only ever record what has already happened in the past.

Your books
Both sets of accounts (management & financial) use the same basic information which they get from the same place - the company's "books".  We shall describe what type of books you will need to keep later in these notes. However first we shall look at your accounts themselves.  

Introduction
We said before that business finance and accountancy are a bit like driving a car. Good drivers use the dashboard to monitor their progress - and in just the same way good business managers use their accounts to monitor their business progress.

So accounts are, in a sense, your business dashboard. The two key instruments on your car's dashboard are probably the speedometer and mileometer. These are equivalent to the two key elements in any set of accounts: the profit and loss account and the balance sheet.

Speedometer 

Speedometer = Profit & Loss Account

In a car the speedometer shows you how fast you are going and how quickly you are getting to where you want to go.

This is equivalent to the profit and loss account, which shows how fast your business is accumulating profits.

Both the speedometer and the profit and loss account only make sense when viewed over a period of time:

• The speedometer shows miles per hour

• The profit and loss account shows profits per year.

Milometer     

Milometer = Balance sheet

The balance sheet, on the other hand, is like the milometer. A milometer records how far the car has travelled and is often used as an important factor in deciding how much a car is worth

In the same way, your balance sheet measures how far your business has travelled. It is a snapshot of where the business has got to and gives some indication of how much it might be worth (but like the milometer it tells us little or nothing about how, or how quickly, it has got to where it is).

Double entry
You may have heard about, and been terrified at the thought of, double entry bookkeeping. If so, relax. We don't usually recommend double-entry bookkeeping to our small business clients. But it is useful to have an idea of what it means.

In fact, the dashboard on your car, and your accounts are both examples of double entry at work:

• On a car, for every extra mph on the speedo, an extra mile is added to the milometer

• In business every extra £ on the profit and loss account adds an extra £ to the balance sheet.

In both cases only one thing happens (either you travel a mile or your earn a pound). But in both cases there are two effects - the mile changes both the speedo and the milometer - the pound changes the profit and loss account and the balance sheet. There are two effects (or "entries"), and so for hundreds of years accountants have referred to it as double-entry. That is really all there is to it.

Basic principles
Most accounting is little more than applied common sense. However there are two golden accounting rules that are not immediately obvious - and so it is worth spending two minutes describing them.

The accruals principle - Your accounts should reflect things when they arise or are earned - which is not necessarily the same as when you actually pay or are paid for them. For example, your accountant will include an April sales invoice in your April accounts, even if your customer doesn't pay you until August.

Revenue v capital payments - Some of the things you spend money on will not be regarded by your accountant (or the taxman) as reducing your profits. For example, the money you pay to buy a new car or pay off a loan. Accounting conventions say that payments like these shouldn't appear in the profit and loss account - instead their effect is confined to the balance sheet.

The key distinction here is between capital expenditure and revenue payments:

• Revenue payments are the running costs of the business - the type of expenses that buy goods and services that are used up quickly (eg wages, advertising, rent, stationery etc). This type of expenditure is shown in the profit and loss account (and is often referred to as having been "expensed")

• Capital payments, on the other hand, relate to things that continue to benefit the company for several years (eg computers, cars etc). They also include paying off loans. This type of expenditure is shown in the balance sheet (and is often referred to as having been "capitalised")

Your accounts
We have now explained the building blocks of every set of accounts. On the next two pages you will see stylised versions of what these building blocks are used to construct - your profit and loss account and balance sheet.

Your balance sheet  

Balance sheets are always presented in two halves. The top half shows the company's net assets i.e.

The bottom half shows where these net assets have come from i.e.

Introduction
Your accounts can only ever be as accurate as the books you keep. In this section we explain the books you will need - and those you won't!

Cash Book
This is your single most important "book". It records all of the payments made into and out of your businesses bank account. It is vitally important to set the book up appropriately at the commencement of business - and we will be happy to advise on this. At the end of each month the totals for each column for that month should be calculated and checked and a separate page should be started for the next month. You should then also do a bank reconciliation (ask us for a copy of our free bank reconciliation factsheet).

Sales invoice file
It is both very helpful to your business, and reassuring to the tax man, if you issue your sales invoices in strict numerical order. You should also set up a file with file dividers for each month and file your sales invoices in strict numerical order. The only exception to this rule is that unpaid invoices should be kept in a special section at the front of the file until they have been settled, at which point you should mark the invoice "paid" and also write on it the date paid, and then file it in strict numerical order. You should also regularly review the unpaid section of the file and take steps to chase payment as often as possible.

Purchase invoice file
This is a file with a file divider for each month and a front section for unpaid bills. On receiving an invoice, file it in the unpaid section until such time as you pay it. On paying the invoice you should write "paid" and the date on the invoice itself, and then transfer it from the unpaid section of the file to the section for the month in which you made the payment. You should also, of course, ensure that the payment is recorded in your cashbook.

Expense claims
Whenever you pay any expenses of the business by using your own money you are entitled to ask the company to pay you back. We recommend you do this fortnightly or monthly and use a pre-printed expense claim form.

Other books
Most small businesses that use the VAT cash accounting method are likely to find that the books described above will be sufficient for both VAT and basic financial control purposes.

Some slightly larger businesses who do not use the VAT cash accounting method also find it helpful to use a number of other types of books such as a:

• Sales Day Book

• Sales Ledger

• Purchase Day Book

• Purchase Ledger

• Petty Cash Book

• Nominal Ledger.

Whilst such books do undoubtedly have their place in a more sophisticated business and accounting environment, they are often not necessary for many smaller businesses, and the cost of the additional training necessary to master their double-entry bookkeeping foundation often far outweighs their additional benefit. Of course, we would be delighted to advise on the most cost-effective and suitable accounting system for the needs of your business.