Accounting simply follows the money flowing within, to, and from, a business. It is important to remember that the accounts reflect the finances of the business, not of the owner(s).
There are three basic financial statements which describe the activities and financial state of any business:
A profit and loss account (P&L) shows a business' trading results over a given period of time, eg weekly, monthly or yearly. It is different from a balance sheet, which shows how a business is performing at a specific point in time. Limited companies are obliged by law to produce a P&L every year; sole traders and partnerships do not have to disclose this information.
A typical P&L for a sole trader or partnership contains the following information:
A balance sheet details your business' assets and liabilities, and shows the financial state of your company at a specific point in time. The assets less liabilities will always equal capital employed, hence the term 'balance' sheet. You should produce a balance sheet at the end of every month, quarter or financial year; you are legally obliged to include at least one balance sheet in your annual company accounts.
A balance sheet comprises the following:
A cashflow statement simply shows all the receipts to, and payments by, the business. Cashflow statements for historical periods usually show what happened for a year, though as with other statements, they can be prepared for any period. The cashflow statement shows how money flowed into and out of the business during the period and relates the P&L (profit and loss) account to the balance sheet. In particular, it shows by how much the working capital in the business increased or decreased and highlights the reasons for the changes. It does not show the amount of working capital available - that is on the balance sheet. Remember that a cashflow statement only shows cash in and cash out, so non-cash items such as depreciation are ignored.
When you consider your strategic objectives and your annual business plan, you will want to define the objectives in financial terms (as well as marketing, quality and people terms). If a key objective is to make money, then one of your targets must define return on capital. If you are in manufacturing, then you are likely to have an investment in capital that is high compared to sales turnover (and, consequently, a low asset turnover).
VAT is tax paid on the value added at each stage of delivery of a product or service. It is a method whereby businesses act as tax collectors for the Government. If you are registered for VAT, by submitting a VAT return you can claim back what you have paid in VAT, and hand over what you have collected.