Maintaining the recording of financial information for a business, known as bookkeeping, involves a number of different areas such as accounts payable, accounts receivable, payroll and so on. All of them are key to ensuring the business’s financials are up to date and accurate. Without accurate and up to date financial information it’s impossible to truly be able to gauge how your business is tracking. Business financials are made up of a handful of different reports which all link together. All of them are based around a chart of accounts.
Chart of accounts
The chart of accounts for a business is broken up into groups of accounts. These groupings are Income, Expense, Assets, Liabilities and Equity. Pretty much all modern accounting systems use double entry accounting which is when opposing amounts are recorded against different accounts in the chart of accounts, a debit to one account and a credit to another. As a result when a report is run showing the balance of every account in the chart of accounts, known as a trial balance, the total of all amounts should always equal zero.
Key reports
The two main reports a small business would use is a profit and loss report and a balance sheet, two very different reports which should be read together to give a true understanding of the businesses position. The two of these reports break up the trial balance into more meaningful reports.
Profit and loss
The profit and loss, as the name implies, takes the income and expense accounts and gives the overall profit or loss for the current year. How the accounts are laid out can vary from one business to the next although they generally follow a structure similar to the below.
Income
Cost of sales
Gross Profit
Operating expenses
Employee expenses/wages
Operating Profit/Loss
Other income
Other expenses
Net Profit/Loss
From the above it is easy to see where the term “bottom line” comes from as it refers to the businesses overall profitability. The profit and loss resets each financial year so it is only representative of the financial year being looked at. This is where the balance sheet comes into things.
Balance Sheet
The balance sheet is made up of the remaining three account groupings, Assets, Liabilities and Equity and, unlike the profit and loss, it is a cumulative report. This means that the balances don’t return to zero at the end of the each financial year but start a new year with the closing balance from the previous year. Where a profit and loss shows you the profitability of the business in the current year the balance sheet is useful for gauging the historical performance of a business.
The account groups in the balance sheet get further split into Current assets, Non-Current assets, Current liabilities, Non-current liabilities and Equity. Each year the Net profit/loss from the profit and loss report gets transferred to the balance sheet and is recorded under Equity (called retained earnings). A brief description of what makes up the balances of each account group in the balance sheet are:
Current assets – Assets which are cash or can be readily turned into cash such as bank accounts, petty cash, inventory, short term investments and receivables.
On-current assets – Assets which are of monetary value but which are not necessarily able to be readily converted to cash. These include Property, plant and equipment including separate accounts for depreciation and Longer term investments (term deposits) .
Current liabilities – Amounts owed by the business which are required to be paid in the near future such as credit cards, creditors, short term loans , GST, PAYG withholding, superannuation, provision for annual leave etc.
Non-Current liabilities – Longer term payables owed by the business. This may include mortgages or long term loans and provisions for long service leave.
Equity – Equity is essentially any initial capital contribution made by the business owner plus any prior year profits (or less prior year losses).
In a balance sheet equity is always equal to assets minus liabilities.
This is just the tip of the iceberg when it comes to useful reports for businesses but the two reports discussed in this post are the main two that small business owners would focus on as they are starting out. These two reports alone may be enough when the business is small but as the business grows so does the reporting requirements.
Of course if you need any assistance with the bookkeeping for your business contact Cygnet Bookkeeping.
Cygnet Bookkeeping 