The What's What of Accounting Terms ...
Posted on: 23/08/2012 By: Maureen Windridge
Hello again. I am intending to publish a series of blog posts that will explain the structure of a set of Accounts. Firstly though, I am going to demystify some of the language that non-accounting people may refer to as gobbledygook or jargon. I am only going to cover profit and loss account items this week ...
understand what's what with your accounting and watch your profits rise
As you'll know by now, MW Bookkeeping offers a comprehensive Bookkeeping service in and around Milton Keynes and clients often approach me to ask for clarification on what can appear a very complex matter. However with the correct explanation, Bookkeeping and Accounting should be easy to understand.
So, sit comfortably and read on for your own Glossary of Accounting terminology and let me begin to paint a very clear picture for you of exactly what's what and everything will fall into place nicely for you! Here we go:
Sales , Income, Turnover
These are all basically the same. They are sales of the goods and or services that a business normally trades in. This figure does not include VAT.
Cost of Sales
The cost to the business that can be directly linked to making sales. If a business is VAT registered this figure will not include VAT as that is reclaimable. If the business is not VAT registered this cost will include VAT as this is a cost the business must carry. The cost of sales will include goods bought for resale, materials bought for manufacture, wages of employees directly involved in selling or manufacture and sales commissions. They can vary between business, more will be explained in future posts.
When the Cost of Sales is deducted from sales the result is the Gross Profit. The Gross Profit percentage is important. The Gross Profit percent in most business stays fairly static. The costs rise and fall in line with the Sales/Turnover rising and falling. A significant variance in the Gross Profit percentage from one period to the next could be an indication of errors in the accounts. This subject could be a blog post on its own and I will come back to this in another blog post.
Expenses are also sometime referred to as "Overheads". The are the costs the business will incur regardless of the value of sales. There are some differences here between Limited company accounts and sole trader or partnership accounts. A Limited company will include Directors' salaries and remunerations in the Profit and Loss account. Sole trader's drawings are not part of the Profit and Loss account. Loan and Hire Purchase repayments will include both interest and capital. Only the interest is included as an Expense in the Profit and Loss account. Depreciation is also included in the Profit and Loss account although it does not involve any money changing hands. Depreciation is a way of charging the cost of a fixed asset to the business over the period of its useful life. It also appears in the balance sheet and will be explained in more detail next week.
The Expenses or Overheads are deducted from the Gross Profit to give the Net Profit of a business. This is usually stated before tax and it is, given some adjustments for none allowable expenses, the amount the business will pay tax on. The amount of net profit after tax is the value of funds that a sole trader or partners are allowed to use for drawings or a Limited company is allowed to use for dividends to shareholders.
I have endeavoured to keep this fairly simply and hope I have used plain language which you can understand irrespective of your knowledge levels in this area. However if there is anything you don't understand please call me on +44 (0) 1908 692378 and let me know - I'll happily take the time to chat matters through with you.
Next week I will be explaining the sections of the balance sheet and items within those sections, so watch this space!
Until next time ...
I consider myself to be incredibly lucky because I am a bookkeeper. At the age of thirteen I did a three year course in three months and passed with distinction. Many years have gone by since then and I am still fascinated by the process of double entry bookkeeping. A process developed over 500 years ago by a venetian monk called Luca Pacioli.
Many people would like a machine that they could put all their paper work into at one end and it would come out the other end all sorted totalled and balanced. I'm glad it hasn't been invented because it would take all the fun out of my work!