Understanding and managing the finances of your business must involve understanding and managing your business’s accounts. This is an area where many people feel uncomfortable and which many business owners shy away from, seeing accounting as a technical and complex area.

The purpose of the remainder of this section is to provide an overview of what the accounts can tell you as an owner manager and to provide some tools (ratio analysis) that you can use to extract useful information with which to manage your business and its finance requirements. If you are familiar with reading accounts you may therefore wish to skip this and the following chapter. If not, you may wish to work through each subsection of these two chapters to ensure that you are comfortable with each element, what it is showing you and why. You may also find it useful to revisit these two chapters at a later date.

What Are Accounts And Why Are They Important?

A set of accounts is simply a record of:

• the business’s trading performance over a period, a profit and loss account;
• a snapshot of its financial position at the end of a period of trading showing its assets and liabilities, a balance sheet.

Accounts have two principal uses.

• They are a means of providing you as the business owner with understanding and control of how the business is performing. As such they can be produced annually, quarterly, monthly or even weekly if that is how detailed the control of the business needs to be. Accounts in this sense (prepared primarily for internal consumption and known as management accounts) are part of what is known as a business’s management information systems (or MIS), where they may be tied into other reports such as key data (eg, orders in the pipeline, production efficiencies, wastage rates), compared with budgets, to see whether the business is on track, and used as the basis for cashflow forecasting to establish the finance required.
• They are also a means of communicating how the business is doing to third parties who may need to know, such as the tax man, the bank, or suppliers who you would like to give you credit. As shown in Chapter 1, part of the price of limitation of liability is a requirement to publicly file annual accounts so that people who are dealing with a limited liability company can assess its financial position.

How Are Accounts Prepared?

Accounts are prepared from the books and records kept by the business and will generally be prepared in accordance with what is known as UK Generally Accepted Accounting Practice (GAAP).

UK GAAP is the overall term for what you might think of as the rules of the game in that, in order to make accounts as easy to interpret as possible, it dictates:

• the basic assumptions which it will be expected that any set of accounts should follow;
• a standardised approach to laying out the information so that one set of accounts looks more or less like another. The accounts shown below show a simple profit and loss and balance sheet for Widget Co Ltd that might form its management accounts.

You’ll find that published sets of accounts, the formal sets that are prepared for filing at Companies House, may look different from this because, for example, the overheads will normally be consolidated into a single figure, thus showing much less detail than in the management accounts.

If you’re not familiar with accounting practice there are a small number of these key underlying assumptions that you need to be aware of to make sense of any set of accounts. There may be occasions where a set of accounts deviates from one of these key assumptions, but if so this should always be clearly indicated in the accounts so that the readers are aware of this.

In a published set of accounts the policies and specific assumptions made, such as depreciation policy, will be set out in the first of the notes to the accounts.

The four key accounting concepts are as follows.