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I’m sure a good number of us have been in a position where we go to a garage for our cars and the mechanic is talking about everything that’s going wrong with them and explaining all the things they’re checking on the car and we just nod along and pretend we know what they’re talking about, whilst really we understand so little of what they’re saying that they might just as well be speaking a foreign language! But at the end of the day the mechanic fixes our car and we’re able to drive around safe in the knowledge that someone, who knows far more about the vehicle, has checked it and deemed it safe to drive.

I’m sure it’s the same when people are talking to us or reviewing your accounts. There are a lot of terms in your accounts that you don’t see anywhere else, and for someone who doesn’t have a background in accountancy I can appreciate just how confusing it can be trying to read and understand the figures in your accounts without any explanation of what all these terms mean. Certainly that’s what I’ve experienced when using accounting jargon around my friends and family!

Whilst it means a lot to know that you trust us to produce your accounts and calculate your tax on your behalf, at the end of the day it is your responsibility to ensure that these accounts and tax returns are correct and so it’s important that you understand what you’re looking at when we send you these documents.

That’s the reason for this blog, I thought it might be useful to give a guide to help you understand your accounts, rip away those accounting terminologies and replace them with simple explanations and why these things are important. Below I’ve covered some of the main headings you are likely to see in your accounts and run through exactly what they are and how they are likely to be made up.

To start off with, let me give a quick rundown of what you might see in your accounts. There are numerous pages and notes that make up your accounts, and the notes that are included will vary from client to client depending on whether you run a limited company or whether you trade as a sole trader or as a partnership, but regardless of the legal vehicle through which you run your business, your accounts will always have a profit and loss account and a balance sheet.

This is the first of a two-part series of blogs. Below I will tackle the difficult terminology you might find on a profit and loss statement, and next time I’ll look to explain the terminology that you’ll find on a balance sheet.

Profit and Loss

This page in the accounts shows you a breakdown of the profit or the loss that your business has made in the year, with comparative figures for the prior year to help give you an idea of how your business is performing year on year. This will contain all your income and all your expenses in that period, which will then work out to either a profit or a loss. You may see ‘gross profit’ and ‘net profit’ as part of this report, and I’ll explain what these terms mean later on.

Turnover

This is the first figure you will see at the top of your profit and loss account. This will contain all of your sales from your business during the year. This might say turnover, work done, sales or something else, but they all just mean the income you have received for the work you have done in the year.

Cost of Sales vs Administrative Expenses

These are both types of expenditure that you have incurred during the year. There is a subtle difference between them however: –

Cost of sales are expenses that without them, you could not have made a sale as you would have had nothing to sell or no way to complete the work for which you have been paid. This will contain items such as materials, subcontract labour, any costs directly involved in creating the goods, providing the service or any goods purchased for resale in the year.

Administrative expenses are the indirect, everyday costs incurred as part of the day-to-day running of a business, the costs that aren’t directly attributable to the production of goods/provision of services but without them you wouldn’t have a functioning business. These will include costs like insurance, professional fees, bank charges, telephone costs, printing, postage and stationery and many more!

Gross / Net Profit

You may see 2 separate profit figures on your profit and loss account, one called gross profit and the other called net profit.

Gross profit is the profit you have made on your sales after deducting the cost of sales, things like materials, subcontract labour, equipment hire etc, any direct cost that you couldn’t have made your sales without.

This gross profit figure allows you to see what sort of mark up or profit margin you’re making, and it gives you an idea of the level of profits you have available to cover the remaining administrative costs incurred by your business.

Net profit is the profit made by the business after taking everything into account, sales, cost of sales, administrative expenses and all other relevant income and expenditure in the year.

This net profit is the profit figure we will use to calculate any tax liabilities arising out of the accounts we have prepared.

I hope this guide has helped clear up a few questions or made reviewing your accounts just that little bit easier!

If you do have any questions about your accounts or anything else we’ve told you please feel free to get in touch with us, just pick up the phone (01284 755956) or send your client manager an email and we’ll be more than happy to answer any questions you have.