Reading Your Accounts: A Plain-English Guide

Accounts are a story in three parts

A set of accounts looks intimidating until you see that it tells one story in three ways. The profit and loss account says what you earned and spent over a period. The balance sheet says what you own and owe at a moment in time. The cash flow statement explains how your cash changed. Each answers a different question, and you need all three to understand the business.

The profit and loss account

Also called the income statement. It starts with sales, deducts the direct costs of making those sales to give gross profit, then deducts overheads to give operating profit, then deducts interest and tax to give profit after tax.

• Gross profit shows whether each sale makes money before overheads.
• Operating profit shows whether the business covers its running costs.
• Profit after tax is what belongs to the owners, and can be kept or paid out.

Watch the percentages as well as the amounts: gross profit as a percentage of sales (the gross margin) and operating profit as a percentage of sales.

The balance sheet

It lists assets (what the business owns and is owed), liabilities (what it owes), and the difference, which is net assets or the owners’ stake. Within it:

• Fixed assets such as equipment and vehicles.
• Current assets: stock, debtors (money owed to you), and cash.
• Current liabilities: creditors (money you owe), tax and VAT due, short-term loans.
• Long-term liabilities: loans repayable over more than a year.
• Equity: share capital and retained profits.

The cash flow statement

It shows where cash came from and where it went: from operating activities (the business itself), from investing (buying or selling assets) and from financing (loans and share capital, and repayments). It helps explain why a profitable business can run short of cash, for example when profits are tied up in stock and money owed to you.

Five figures worth watching

Trends matter more than single figures: compare each with last year, with your plan, and, if you can, with others in your sector.

Statutory and management accounts

Statutory accounts are prepared once a year for Companies House and HMRC, in a prescribed format, and are filed publicly in a form depending on the size of the company. Management accounts are prepared more often, such as monthly, in a format that helps you run the business. If you read your accounts only once a year, you are reading history. Regular management accounts let you act while it can still make a difference.

Questions to ask your accountant

• What are the two or three numbers I should watch?
• What changed most since last year, and why?
• What would worry a lender about these figures?
• How do we compare with similar businesses?
• What would you do differently?

Related guides

If this is useful, you may also want:

• Management reporting
• Budgets and cash forecasts
• Cash collection