“Accounts” can be a general term banded about, often instilling fear in those not financially minded. Here we give you a first step to start understanding accounts and some of the simpler terms used in them.

What are accounts?

In their simplest form, business accounts may consist of a schedule showing income and costs of the business in a period (often referred to as a “Profit & Loss Account” or “Income Statement”) and a schedule showing what your business owns and what it owes, at the end of that period (“Balance Sheet” or “Statement of Assets and Liabilities” etc).

Accounts may also include a schedule (“Cash Flow Statement”) showing how cash has been generated and spent by the business.

Here, we are talking about accounts which show what has happened in the past. Accounts are often drawn up by business, incorporating estimates of what the owners think may happen, or wish to happen in the future. These are referred to as “budgets” or “forecasts”, but that’s a matter for another day.

For a company (or a limited liability partnership), there are prescriptive rules governing how accounts (“Financial Statements”) should be drawn up, but these are more relaxed in the case of a small sole-trader business. Your accountant should explain what you require and construct accounts accordingly.

Profit & Loss Account

To keep things simple, we look at one schedule or financial statement here, the profit & loss account. In it’s most basic form, this might look like this:

Turnover 8,000

Costs (2,300)

Profit before tax 5,700

(Note that accountants often use brackets round a number to mean it is negative or, in this case, instead of a minus sign to show that it should be subtracted from the number above. Just another way to confuse you!).

This shows that in this period, your business made sales or income of £8,000 (“turnover”), but also had incurred costs of £2,300 to generate this income. Therefore the business made a profit of £5,700.

You might not have actually received the cash in for the £8,000 of sales, and you might not have actually paid for all your costs yet e.g. if you’ve not received your electricity bill yet, but have powered your computer/used your office, then these costs should be included. So for many businesses cash is more important than profit, particularly at the start of the activities, but more of that another time.

Costs

In reality, costs relating to a consultancy business are often low compared with income, but without including them, you may overestimate how well your business is doing, and may even overpay tax!

Examples of costs might be train travel to see a potential customer, advertising expenditure, insurances such as professional indemnity, interest on loans e.g. if you have borrowed money to purchase equipment such as a computer etc. Your profit & loss account might show all these costs separately, rather in one line as we have shown above.

However, the cost of the computer itself would not be included in full here. You might expect the computer to last, say, three years and so include a third of the cost in each set of accounts for the next three years. This fraction of a cost of an asset like a computer is known as “depreciation” and your accountant will be able to advise on how to calculate a meaningful figure.

Turnover less costs gives the profit before tax for the period. Your accountant will help you calculate what tax is payable on these profits, whether you are a sole trader or operating as a company. Knowing how much profit you are making is one piece of information that can help you make decisions about your business.

As with all our information in The Business Lounge, this is not comprehensive tax advice, and may not apply to your specific circumstances; to discuss how these issues affect you, contact your accountant.