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Finance basics for small businesses

An accounting qualification may not be needed to succeed in business but there are basics of financial management that need to be understood. Certain tools and measures will need to be mastered in order to monitor performance success.

Limited companies need to be aware of the key tools required to form part of these statutory accounts needed by Companies House; the profit and loss account and the balance sheet.

Profit And Loss Account
This records all sales income, costs and expenses (whether received as paid or not). It also shows business performance over the specific period.

Figures in the profit and loss account comes from a number of sources in your business. Get good advice from the start of the best way to categorise and layout day to day receipts and expenses. Advice from an accountant or bookkeeper is best. Or use the business support team at HMRC.

Some flexibility and judgement is needed when calculating the profit and loss account. For example, fixed assets depreciation period and adjustments for bad debt. Use a qualified accountant to find out what is reasonable and acceptable.

A profit and loss account is usually set up like this:

Income 50,000
less discounts and allowances (5,000)
Net income =45,000
Less direct costs (cost of sales) (20,000)
Gross profit =25,000
Less indirect costs (fixed overheads) (7,000)
Operating profit =18,000
Plus other income 2,000
Less other expenses (1,000)
Profit before tax 19,000
Less tax (8,000)
Net profit (or net loss) =11,000

Key points to remember are:
  • Business performance over a specific time are shown.
  • Income is recorded against outgoing to ascertain profit or loss.
  • Raised invoices are summarised and sales income shown which includes estimates of works in progress but not yet invoiced.
  • Includes purchases made from suppliers and estimates a cost for goods/raw materials used but not paid for.
  • Does not indicate amount of cash generated, as it has no record of whether invoices are paid or amounts remain outstanding.
The Balance Sheet
Provides a view of the business' value at a specific point in time. Assets (what the business owns) are summarized, as are the liabilities(what others owe to the business).

A balance sheet is typically split into:
  • Fixed assets. Intangible assets, plant and machinery etc.
  • Current assets. Stock, works in progress, cash etc
  • Current liabilities (due for payment within one year). Trade creditors, bank overdraft etc.
  • Long term liabilities e.g. loans.
  • Shareholders funds.
Flexibility and judgement is also required in calculating the balance sheet. Knowing how to value intangible assets, stock or work in progress. Advice must be sought from a qualified accountant as they are up to date with changing rules and what is considered good business practice.

Balance sheets are usually set out this way:

Fixed assets (listed by item) 100000
Depreciation (listed by item) (20000)
Total fixed assets 80000
Current assets 5000
Current liabilites (eg bank loan tax) (90000)
Equity 100000
Profit from previous year 75000

Key points for balance sheet:
  • Provides a view of business' value at a specific point in time.
  • Total assets and capital at year end must always balance, (hence the name)
  • Measures ability to pay money owed
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