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Understanding business accounts

Business accounts give an overview of the liquidity of your business and show whether you have enough cash to pay your liabilities. This article will give you an understanding of the importance of business accounts, what they cover and how they’ll help you make crucial day-to-day and short-term managerial decisions.

What are business accounts?

Business accounts are a record showing:

the financial performance of a business (over a given period)
and the financial position of a business (at a certain date).

Why do we need accounts?

Accounts gives an overview into the liquidity of the business in that it shows whether you have enough cash to pay your liabilities (before you actually have to). This allows you to take measures before the situation becomes urgent. These measures might include:

cutting down on spending
increasing supplier payment terms
taking out a loan to increase cash value and pay short term creditors.

It is important for a business to understand how much profitit has made to give it an idea as to whether the business is successful. Sometimes when a business owner is busy it is not always easy to see whether the business is actually making any money. With so much going in and out of the business, calculating profit helps give some clarity.

It is worth mentioning however, that profit is different to cash. Some things will affect the cash flow of the business but won’t affect profit, e.g. money taken out of the business for personal use. Likewise, some items will affect profit but will not affect cash, such as provisions, e.g. where a business makes an adjustment for a customer not paying.

Profit and loss account

A profit and loss account (also known as P&L) is one of two main statements (the other is the balance sheet) that is prepared to measure the performance and position for a business for a period of time – ie a month, quarter or year. The profit and loss account is always prepared for a given period, usually 12 months.

A profit and loss account measures profitability and along with your balance sheet will show your long term prospects and help identify how you can improve and manage your business better.

It shows the difference between the value of the items sold (revenue) during that period to the costs and expenses involved in generating revenue for that period. The total outgoings (revenue) are subtracted from the total income (costs and expenses) and will show you how much profit you have made.

Balance sheet

A balance sheet shows the value of a business in terms of its assets and liabilities.

The net value of a business is calculated by taking the total assets of a business, minus its total liabilities. Total assets include fixed assets and current assets. Total liabilities include both short term liabilities and long term liabilities.

Cash flow statement

In addition to the profit and loss and balance sheet, some businesses may prepare a cash flow statement showing the movement in cash from one period to the next.

This will take into account all cash movements, such as dividends paid, capital assets purchased and actual cash paid and received for sales, costs and expenses.

How often do I need to produce accounts?

Accounts are usually prepared annually but there may be situations where a longer or shorter accounting period is required e.g. when a business starts trading (if they have a desired year end to prepare their accounts to) or when it ceases to trade.

What are management accounts?

Management accounting involves preparing and providing timely financial and statistical information to business managers so that they can make day-to-day and short-term managerial decisions.

Management accounting is different from financial accounting, in that it produces reports for a company’s internal stakeholders, as opposed to external stakeholders. The result of management accounting is periodic reports: for example, sales for a particular department or a costing analysis for a certain product range. Budgeting, costings and forecasting are all features of management accounts.