The way accounts are managed varies greatly depending on the type and size of business you are running. Keeping track of things can be complex, but to help you we’ve put together the first of two blogs to help you identify whether you are allocating monies the right way.
Understanding the type of transaction
When it comes to financial transactions there is a common misconception that bank transactions (actual money transactions) are the driver of the profit and loss account income and cost balances. Although there is a cash accounting scheme that does just this it is not a method that works for all businesses - there are a number of disadvantages (and it can only be used for businesses with turnover under 1.35 million).
How to monitor your sales and costs accurately
Any business that wants to monitor its sales and costs accurately will use the ‘accruals method’. This accounting method uses invoice receipts and other similar documents to record sales, cost of sales as well as any expenses or overheads relating to the period in question (regardless of whether they have been paid or not).
Using the accruals method the question of ‘are you allocating monies in the right way’ is fairly simple. Inflows to the bank will be primarily from customers who owe you money, and outflows will most likely be to pay suppliers of goods or materials (or wages depending on your type of business). As an accountant I would recommend that when recording wages you as the business owner, or your bookkeeper would make a record in the ‘wages control account’ as the wages and salaries due would have been recorded before payment was made. Naturally, there will also be some expenses incurred which would not be recorded as credit supplies as they have been paid for at the point of sale (i.e. petrol or coffee for staff consumption).
How to apply these methods to different types of business
As mentioned earlier every business is different. For example, when it comes to managing the accounts for a shop or pub you would not record money owed from customers as it simply receives money as soon as it has sold an item or consumable. Therefore, money coming into the bank of a shop or pub would mainly be recorded as coming from sales and VAT owed to the revenue.
However, if you take a typical VAT registered distributor of say homewares, the business would receive a lot of supplier invoices for stock and would produce a lot of customer invoices for selling the stock on to retail outlets. The customer invoices would be recorded as sales and VAT owed, and the supplier invoices would be recorded as purchases and VAT reclaimable (these would be the entries for the core transactions of the business).
A business such as the homewares distributor would need to buy equipment, and potentially delivery vehicles. This is where an appreciation of the difference between capital items and revenue items is essential. Motor vehicles will last a number of years so only a proportion of the cost will be charged to the profit and loss account to decrease profit (known as depreciation). The main outlay should be recorded in the Motor Vehicles account and this will appear on the balance sheet of a company’s accounts. The balance sheet is for displaying the assets and liabilities of a company on a given day, whereas the profit and loss account is for showing the profit of a given period. This is the starting point used for calculating annual tax liabilities.
Getting to grips with the correct allocation of monies can take time, and what we’ve covered in this blog is just the tip of the iceberg. In our next accounting blog we will share our insight on how these factors apply to management accounts, and how you can ensure your transactions are being accurately recorded.
Don’t have time to check back here? You can sign up for our email newsletter and have our latest blogs sent straight to your inbox - just click here. Alternatively, if you need a hand give us a call on 01243 532490 or email firstname.lastname@example.org.
This blog was written by Monica Jervis, small business owner, founder of the Chichester Accountants and qualified accountant. If you’ve got any questions don’t hesitate to get in contact on Twitter, Facebook or Google+.
Tel: 01243 532 490
Professional Indemnity Insurers:
Hiscox Ltd Policy Ref:CHICIOWQ01
Territorial coverage is Worldwide excluding claims brought in USA/Canada.
Forum House, Stirling Road, Chichester, West Sussex, England, PO19 7DN
Company No: 07327325