- Financial and management accounts: the basics
- Understand the basics of business banking
- How to choose and manage a business bank account
- Balance sheets: the basics
- Profit and loss accounts: the basics
- Business Income Sales
The accounts management needs of your business will vary according to the size, type and sector of your business. As the business owner, you’re responsible for ensuring your business keeps accurate financial records and accounts. Key areas to consider include:
- financial and management accounts
- balance sheets
- profit and loss accounts
- how to set up a record-keeping system
You’ll also need to think about your business banking needs to choose and manage a business bank account.
2. Financial and management accounts: the basics
There are 2 types of accounting information - financial accounts and management accounts.
Financial accounts - are a historical record of your business' performance over a period - usually 1 year - for the benefit of external users such as shareholders, employees, suppliers, bankers and authorities. They have to be filed at Companies House.
Financial accounts normally include:
- profit and loss account
- balance sheet
- cashflow statement
- statement of recognised gains and losses
- unincorporated businesses
Limited companies are obliged by law to prepare a set of financial accounts each year and to file a copy with Companies House. There are statutory penalties for late or incorrect filing, for which the directors are liable. Small and medium-sized companies are allowed to file accounts with certain information omitted.
Management accounts - are aimed at helping you to plan your business and make decisions about key areas such as sales, margins and stock. They can help you make timely and meaningful management decisions about your business. Different businesses will have different management accounting needs, depending on the business areas that are important to them. These include:
- the sales process - such as pricing, distribution and debtors
- the purchasing process - such as stock records and creditors
- a fixed asset register - details of all fixed assets, including identification numbers, cost and date of purchase, etc
- employee records
There’s no legal requirement to prepare management accounts, but it is hard to run a business effectively without them. Most companies produce them regularly - eg monthly or quarterly
3. Understand the basics of business banking
You're likely to need a business bank account. Take the time to research what different banks have to offer, including their services, fees, interest rates and bank charges.
When you're approaching a bank for funding, you'll need a credible business plan. A bank will look at this and your track record in business to decide if you're a good risk.
See our section on how to use your business plan to get finance.
To lend, a bank may ask for security, like a personal guarantee, and will normally want to see your own money in the business too.
The success of your business could depend on the relationship you have with a bank. So it's important to manage your business account properly, staying in credit and keeping to the terms and conditions.
Usually, a bank agrees to an overdraft facility or a bank loan to lend money to a new business. An overdraft is good for day-to-day expenses and frees up cashflow, while a loan is better for longer-term financing.
There are other types of bank finance, such as working capital funding and commercial mortgages, which can be arranged to suit your business needs.
There are also alternatives to bank borrowing, collectively known as non-bank finance. These include commercial loan providers, peer group, social and community lending or government funding schemes. See our section on non-bank lenders.
4. How to choose and manage a business bank account
A good relationship with your bank is essential to the success of your business. You need to spend time choosing the right bank and the right business bank account and manage it effectively, you should also compare the different services and costs. Your relationship with your bank will be improved if they understand your business.
The services offered by banks differ greatly and so do the fees. Some banks have special business account teams and can offer special deals to new businesses, or useful start-up information. Banks offer a range of competitive business account packages allowing you to negotiate or switch for a better deal.
The type of account(s) you choose will depend on your business' needs. For example, if you make frequent transactions, a fixed-fee account may be more cost effective than one that charges per transaction. Some accounts also allow free direct debits or standing orders.
As your business grows and changes, you may find that the terms and conditions attached to your business bank account are no longer best for your business. Regularly review your account and consider switching to a different account if required, or negotiate changes to the terms and conditions of your account.
Try to keep to the terms and conditions of your account. It's better to change the conditions of your account rather than breach an agreed term - eg exceeding a credit limit.
Try to avoid your business account becoming overdrawn - unless an overdraft limit has been agreed. And don’t exceed overdraft limits without agreement. This will incur extra fees and could affect your credit rating.
5. Balance sheets: the basics
A balance sheet provides a summary of what your business owns or is owed (assets) and what it owes (liabilities) at a particular date.
The balance sheet shows how your business is being funded and how you are using these funds. There are 3 ways you can use your balance sheet:
- for reporting purposes as part of a limited company's annual accounts
- to help you or investors, creditors or shareholders to assess the worth of your business at a given moment
- as a tool to help you analyse and improve the management of your business
Limited companies and limited liability partnerships must produce a balance sheet as part of their annual accounts for submission to:
- Companies House
- HM Revenue & Customs (HMRC)
- shareholders - unless agreed otherwise
There are strict deadlines for submitting annual accounts and returns to Companies House and HMRC – there might be a fine for late submission.
A balance sheet must include:
- fixed assets - long-term possessions
- current assets - short-term possessions
- current liabilities - what the business owes and must repay in the short term
- long-term liabilities - including owner's or shareholders' capital
A qualified accountant can help you decide how to present the information.
The figures in your balance sheet can change significantly in a short space of time. However, the total net assets (assets less liabilities) would only change significantly if your business was making large profits or losses.
There are some simple balance sheet comparisons you can make to assess the strength or performance of your business, including:
- internal and external comparisons
- trade debtors comparisons
- borrowing as a percentage of overall financing (gearing)
For more information see our guide Business records if you're self-employed.
6. Profit and loss accounts: the basics
A profit and loss account is a summary of business transactions for a given period - normally 12 months. By deducting total expenditure from total income, it shows on the 'bottom line' whether your business made a profit or loss at the end of that period.
A profit and loss account shows owners, shareholders or potential investors how the business is performing. Most of the information is also used by HM Revenue & Customs to check your tax calculations.
By law, if your business is a limited company or a partnership whose members are limited companies, you must produce a profit and loss account for each financial year.
For example, if your business is a limited company, the company will report its profit (or loss) through annual accounts and a Corporation Tax return. You also need to report your own personal income from the business, for example as a company director, on your Self Assessment tax return.
If your business is a partnership, the nominated partner must complete a Self Assessment tax return for the partnership. In addition, you need to report your own personal income from the business on your own Self Assessment tax return.
Self-employed sole traders and most partnerships don't need to create a formal profit and loss account - but they do need to keep adequate records to complete their Self Assessment tax return fully and accurately.
Key benefits to producing formal accounts are;
- if you are looking to grow your business
- or need a loan or mortgage, as most institutions will ask to see 3 years' accounts.
Profit and loss reporting requirements vary. Whatever your business type, you must keep accurate records of your income and expenditure. You need to keep self-employment records for 5 years after the 31 January deadline - and you may need to keep them for longer if you file your return late or if HM Revenue & Customs starts a check. You need to keep limited company or partnership records for 6 years after the latest date your tax return is due.
The basic records you will need to keep are:
- a record of all your sales and takings
- a record of all your purchases and expenses
- a separate list for petty cash expenditure if relevant
- a record of goods taken for personal use and payments to the business for these
- a record of money taken out for personal use or paid in from personal funds - this applies to limited companies
- back-up documents for all of the above
You will need the information above to create your profit and loss account and to complete your tax returns.
For more information see our guide Business records if you're self-employed.
7. Business Income Sales
Business income falls into 2 categories for profit and loss reporting:
- sales or 'turnover'
- other income
For information on the second category, see the page in this guide on business income: other
Business sales or turnover
Your business' total sales of products and/or services in a trading year is referred to as turnover. This is the starting point for your profit and loss account.
How you record sales will vary according to your business type, size and whether you are VAT-registered. You may use a simple list or 'ledger' in a book, a tailored spreadsheet, or a computer software program. Whichever system you use, you need to ensure that it is accurate and updated regularly.
Sales records back-up
The back-up records for your sales ledger fall into 2 categories, and will vary according to your business type:
- copies of sales invoices issued by you
- rolls of till receipts
- records of money you pay into the business when taking goods out for personal use - note that if you take goods out of your business without paying for them you still owe the business for them, and so will have to add the retail cost of the items to your overall pre-tax profit figure
Proof of income relating to the above:
- paying-in slips
- bank/building society statements and similar
If you operate on a 'cash only' basis you must keep detailed records of your income in your sales book or ledger and be able to relate these to your expenditure, cash in hand and bank statements.
8. Business Income: other
As well as reporting sales income, you need to report income to the business from other sources, for example:
- interest on business bank accounts
- sale of equipment you no longer need
- rental income to the business
- money you put into a limited company from personal funds
Recording other income
- record equipment sales in your sales ledger, or on a separate schedule of assets if you prefer.
- keep a record of any rental income, for example if you sub-let part of your office to someone else.
You must keep paying-in slips and/or bank statements to account for your additional business income. Ideally, you should be able to cross-reference this documentation to the above 'other income' records.
9. Recording business expenditure
Business expenditure falls into 3 key areas for the purpose of reporting your profit or loss. You can save yourself, or your accountant, time by grouping your costs accordingly in your purchase list or 'ledger'. The 3 key areas are:
- cost of sales - the base cost of obtaining or creating your product
- business expenses
- cost of equipment you have bought or leased for long-term use
If your business is VAT-registered, you will need to record details of any VAT included in your expenditure.
Business expenditure back-up
The back-up records for your business expenditure fall into 2 categories. As with sales records, they will vary according to your business type:
1. Purchase/expenditure documentation:
- copies of supplier invoices/receipts issued to you
- till receipts for items bought over the counter
- payroll and National Insurance records if you have employees
2. Proof of expenditure relating to the above:
- cheque book stubs
- bank statements
- credit card statements and receipts
It is important for you to be able to cross-reference your records to your expenditure figures if asked. If you mislay a receipt for a small item, make sure you enter it in your purchase or petty cash book ledger and make a note that you have lost the receipt
10. Cost of sales
The cost of sales is the cost of obtaining or creating your product.
This might include:
- the cost of stock you buy for resale
- components/raw materials to make your product
- labour to produce the product
- machine hire
- small tools
- other production costs
When you create your profit and loss account, you deduct your cost of sales from your overall sales, or turnover, to arrive at your 'gross profit'. This is your profit before deduction of expenses.
Cost of sales does not usually apply if you supply a service only.
11. Business expenses
These are all the ongoing expenses associated with running your business that you can deduct from your 'gross profit' figure on your profit and loss account to calculate a figure of 'profit before taxation'.
Legitimate business expenses for accounting purposes are:
- employee costs
- premises costs
- general administration
- motor expenses
- bad debts
- legal/professional costs
- other finance charges
- depreciation or loss - profit - on sales of equipment
- any other expenses
Note that some elements of these expenses are not allowed for tax purposes and are added back before your taxable profit is calculated.
Apportioning expenses - self-employment and partnerships
Where expenses apply partly to business and partly to non-business or personal use, you need to exclude any expenditure that relates to non-business use. For example, if you use your car for both business and private purposes, you normally work out the allowable business and non-allowable private proportions based on the mileage covered for each.
When filing invoices, remember to note any apportionment on them.
12. Cost of equipment
Any items of equipment you have bought or leased for long-term use are called 'capital items' or 'fixed assets'. These might include:
- computer equipment
- cars or vans necessary for the business
Depending on the size of your business, you can record the cost of equipment you buy in a separate register of equipment, the 'fixed asset register', or you can include it in your general expenditure records and show it as a 'capital item'.
Depreciation and allowances
The cost of capital items is not deducted from your profits in the same way that ordinary business expenses are. Instead, you make a charge for depreciation each year, reflecting the fall in the value of the asset over time. This spreads the cost of the asset over several years.
For your own profit and loss, you typically choose a depreciation charge that provides a realistic reflection of how long the asset will be useful. For example, you might expect a computer to be obsolete after 3 years, so charge a third of its cost against profit each year.
For tax purposes, depreciation is not an allowable expense. Instead, there are set allowances that you can claim. For small businesses, the costs of most asset purchases can be fully claimed against tax using the annual investment allowance (up to an annual limit of £100,000).
13. Profit and loss account period and tax
Businesses normally work out their profit and loss for a 12 month period. This makes it easy to see how well your business is doing each year, and to compare 1 year with the next.
The way your accounts are taxed depends on what type of business you have.
Accounts for self-employed and partnerships
Self-employed sole traders and business partnerships are normally taxed on the profits for the 12 month accounting period ending during the tax year. The tax year runs from 6 April to 5 April the following year.
For example, if you make your annual accounts up to 31 December each year, your profits to 31 December 2010 are used in your 2010-11 tax return (for the year to 5 April 2011).
The simplest approach can be to make your annual accounts up to 31 March or 5 April, so that they match the tax year.
Special rules apply when you start or close a business, or if you decide to change your accounting period, to ensure that all your profits are fairly taxed.
To find out more about accounting periods for the self-employed and partnerships, download a helpsheet on how to calculate your taxable profits from the HM Revenue & Customs (HMRC) website (PDF, 94K)
Accounting periods for limited companies
Limited companies are required to submit annual accounts to Companies House, including a profit and loss account.
When you start a new company, the financial year automatically runs to the end of the month a year after the company is incorporated. For example, if a company is incorporated on 10 June, the first financial year runs from 10 June to 30 June the following year. But you can choose a different financial year end if you wish.
Your profit subject to Corporation Tax is normally based on an accounting period that matches this financial year. There are special rules if your accounting period is longer than 12 months (for example, if your new company makes up its accounts to a date more than a year away).
Last updated 21-04-15