Whats inside
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.
Whats inside
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.
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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.
Basic principles
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 What you own, and what you are owed Liability What you owe (loans, supplier credit) Capital Your company equity
Revenue Records sales made Expense 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”.
Balance Sheet
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.
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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
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;
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!
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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.
Trial Balance
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.
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