There are many definitions but simply put your Accounts are the documents showing exactly how your business is performing in financial terms.
Every business, whether a sole trader or a limited company, must keep accounts and accounting records (the data that makes up the accounts).
Why do you need Accounts?
It’s essential to keep your accounts up to date not least so you know how much you can extract for your own spending but also to:
- meet your legal duties and obligations
- calculate how much tax you owe HMRC
- show investors how well the business is doing
- raise capital for the business
So make the maintenance of the accounts a regular thing and not just an annual event to satisfy the tax man!
What is Profit?
Income – Costs = Profit
Profits cannot usually be worked out by simply adding together the cash receipts of the business and deducting costs paid out.
It’s an Accrual World
For your tax returns to arrive at the profits it is necessary to draw up accounts using the methods which accountants and the tax man have developed for dealing with:
- income that has been earned but not received
- costs that have been incurred but not paid or paid but not fully used
This is known as the accruals method – a word invented to make things sound complicated!
All you need to remember is to record all income and costs as they occur and not just when you pay out the money which basically means that there will be timing differences between the amounts in your Accounts and the amounts in your Business Bank Account.
Note – unincorporated businesses e.g. sole traders can elect to use a system called Cash Accounting for transactions to make things easier which means that you record income as you receive it and costs as you pay for them.
What makes up a set of accounts?
A set of accounts can be made up of a number of items:
- Profit and Loss Account
- Balance Sheet
- Notes to the accounts
- Directors Report
The structure of the business determines which of the above are mandatory e.g. a limited company has to produce accounts in a set format and this is where you may need help from an accountant.