Understanding your limited company accounts
Clients are always telling me that they do not understand their accounts. Clearly they know their business, and how to price to make money so it is only a small step to actually understanding the end of year accounts:
- The very back page or two is the detailed profit and loss account which as the name implies shows the profitability of the business after expenses but before tax. The first figure will be sales or turnover which is the income for the year based on sales actually completed, but not necessarily paid for. From this is deducted the direct costs in making those sales, ie the materials or costs which directly result in the sales being made, but will exclude any stock or work in progress which has not resulted in sales by the year end. This results in a gross profit which should be the profit made on all the individual jobs completed during the year.
- From the gross profit are deducted expenses or overheads which are all the costs of running the business which are not directly involved in generating sales, which will include salaries, rent and advertising for example. There will also be other adjustments for depreciation on assets and finance costs resulting in a net profit before tax.
- The tax is shown on a less detailed profit and loss account which is half way through accounts, normally the first page of figures from the front. This summarises the headline figures from the detailed profit and loss then shows the tax (which will be approximately 20% of the net profit) being deducted to leave a profit after tax from which dividends are paid.
- You will need to turn to the notes to the accounts which are towards the back to see dividends, the actual dividend paid is shown in a note at the beginning and the effect on the company reserves shown as one of the last notes. This will show how much the company was worth at the beginning of the year, how much value was added during the year in profits and how much paid out by way of dividends. This shows the value of the company at the end of the year which takes us to the balance sheet.
- The balance sheet is found just before the notes pages and measures the value of the company by netting off the assets of the company against it’s liabilities. Fixed assets are shown first including vehicles, plant and equipment, each year their value is reduced by depreciation as a measure of their age and usage. This is shown as an expense on the profit and loss account.
- Following fixed assets are current assets which include items more easily convertible into cash such as stock, monies owed by customers and others (debtors) and bank balances themselves. From this are deducted current liabilities which include monies owed to suppliers and others (creditors) and in taxes: corporation tax, VAT and PAYE. The net of current assets and liabilities reflects the liquidity of the company, in general this should be a positive amount in order to service the running of the business.
- If there are long term liabilities such as bank loans or HP these are deducted from the value of fixed and net current assets to show the asset value of the business. This will equal the value of shares owned plus the reserves balance shown in point no #4, hence the name “balance sheet”.
- Some of the figures in the profit and loss and balance sheet, particularly of note the debtors and creditors, are not broken down into their constituent parts and the detail can be found within the notes to the accounts.
The layout of the accounts is laid out in statute and includes parts that may be of little relevance. Your accountant should be able to explain the bits of relevance to you at the end of the year.
We hope you find the contents of this blog useful; you should of course always seek professional advice for your specific needs. Alastair Wood, AW Accounting – Accountants who “speak your language”
