OK it’s not the most original title in the world (nor, I hear you say, the most exciting subject) but this is a quick and easy layman’s guide on the big picture of accounting and some of the principles that every business person should be aware of. I understand that this subject can send half of humanity to sleep and send the other half into palpitations but it is truly simple and there is a nice picture included.
The accounting system is made up of two parts, the Profit and Loss Account (P&L) and the Balance Sheet (BS). It operates a double entry system so that each transaction creates 2 equal but opposite entries which then balance each other out i.e. the sum of the P&L and BS is always zero.
Accounting is the ultimate zero sum game!
Whenever you make a sale, incur an expense, pay wages or undertake any other business transaction you send information to either the P&L or BS or both. This binary system makes accounting exceedingly logical and straightforward. Therefore don’t listen to Accountants who tell you they have still to balance the books, it’s already done for them but their expertise comes in ensuring
The mindmap below outlines the key things about your P&L and Balance Sheet.
Basically the P&L covers a period of time between two balance sheets e.g. the year ended December 2009 is described by the balance sheet at 31 Decembers 2008 and 2009
The P&L outlines the financial performance of the business. It describes the activities that the business undertook and how successful (profit /loss) they were in financial terms. It is more meaningful if it is used with comparative information e.g. last year’s, budget, competitor’s.
The P&L answers questions about how much your sales have increased on last year, what gross margin are you making before overheads, what is your profit that the taxman will take a chunk out of, how is my wage bill against what I budgeted and so on.
The Balance sheet outlines the financial position of the business at a given date. It describes the assets and liabilities and boils down to the net worth or net assets. Also more meaningful if used with comparative information to provide context.
The Balance sheet answers questions about how much cash is in the bank, what are your aged debtors and debtor days, what do you owe in VAT, what is the net worth of the business and much more besides.
So that’s a quick lesson on the basics of accounting. I will follow up with articles to show you how you can practically use some of the information on these two documents to improve your business and benchmark against your competitors.