The holy trinity of accounts

Something that I hear a lot from people is that they are scared or put off finance by a lack of understanding and some of the terminology and jargon used. In reality I suspect this is no different to a lot of specialisms – where training and experience help to make what appears complex more simple.

So the question I think that should be asked is what level of knowledge and insight you should leave to the experts and what should you want or need to know? This question is at the heart of a lot of the training courses I have been delivering over the last few months and those that I will continue to deliver going forward.

Over a series of blogs through the autumn I’m going to try and cover some of the basics of accountancy to help people start to get to grips with “the numbers” and how they are prepared. Content that forms part of the Finance for Non Finance Managers workshops that I run.

Where to start?

Well as an initial overview I am going to try and explain in layman’s terms what the 3 major financial statements are designed to do and show.

  1. Balance Sheet
  2. Profit & Loss Account
  3. Cash flow statement
  4. Balance Sheet

The balance sheet is designed to show the sources of funds into a business and how those funds are being used to run the business.

It will therefore show the equity funding (shareholders’ funds) retained funds (profit from prior periods) and debt funding (loans, mortgages) and how that is being used – through investment in assets used to generate income (both fixed assets such as machinery and current assets such as stock) but also taking account of what the business owes – it’s liabilities.

A balance sheet will always balance and it is stated at a specific point in time and therefore the figures can change from one day to the next – it is a representation of what a business owns and owes at that point in time.

 

  1. Profit & Loss Account

A P&L is sometimes called an income statement or an income and expenditure account. This shows the trading performance of a business over a specific period – usually this is the 12 months of a financial year but can equally be a week, month or quarter.

The P&L summarises the revenue (also called turnover or sales) within the period, in comparison to the costs and expenses incurred in order to generate that revenue.

Profit is sometimes substituted for the term Earnings – in terminology such as EBIT (Earnings Before Interest & Tax) or EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation)

 

  1. Cash flow statement

A cash flow statement shows the movement of money in and out of a business over the course of a trading period (usually the same as the equivalent profit and loss account). This is necessary to account for a number of elements to the other 2 financial statements that are reported or shown on a “non cash” basis – examples would be the depreciation of fixed assets or the purchase of stock that has yet to be used or sold on.

A cash flow statement can be really useful in understanding how much money a business has access to and how that compares to it’s trading performance.

 

The 3 statements combined form a complete picture of a business’s financial health and wellbeing.

I welcome your comments on this content and will be blogging again about the basics of accounting through the autumn.

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