In this interview I speak with Gary Robertson, a chartered management accountant for the last 20 years working at FD level. Gary will be giving some insightful knowledge about finance and accounting terminology.

What is a ledger account?

If you go right down to the simplest level with a sole trader, they might be noting down everything they spend and everything they receive either onto a spreadsheet or perhaps into a manual cash book and putting all the receipts and paperwork into a cardboard box and just giving that spreadsheet or cash book to there accountant with a box of receipts at the end of the year. What the what the accountant will do with all of that information is key it into a system, so if you can imagine all of those transactions for the whole year, all of those ins and outs going into into one big long list of transactions it is effectively your your financial ledger.

But that big long list is not really good enough for either you as a business owner or your accountant to do what they need, because if you want to know what the total sales where for the year, or the materials cost over the period, you’re not going to want to go down that list saying well there’s one there’s, and there’s another, adding them all up.  So when your accountant types all of the transactions into their system they will put theminto categories like little buckets.  One for sales, one for materials costs, one for telephone costs, one for vehicle costs etc. Each one of those buckets is a ledger account. So ledger accounts really are categories of revenue and cost, and all of those ledger accounts added together equal your financial ledger.

What is a Balance Sheet and Profit and Loss

Moving on from the the point that we were at with our accountants where they have taken all of that cash book information and created a ledger filled with ledger accounts, they will turn that into financial statement both for you use and also for calculating your taxes. The two primary schedules that your accountant will prepare are your profit and loss account and your balance sheet.

Each ledger account will fall into one of four categories :-

Income accounts – sales income
Cost accounts – your purchases
Asset accounts – everything that the business owns
Liability accounts – everything that the business owes

Every ledger account will fall into one of those four categories, so when an accountant prepares your accounts they will take all of the income and expenditure accounts and the list of income and expenditure ledger accounts and summarize those into a one-page document. 

Your profit and loss account will show you in a easily digestible way your sales and costs where for the year and therefore your profit for the year.  This will tell you at a glance how your business has performed for the year. Then likewise they would take your assets and liability accounts to summarize those into a balance sheet and that balance sheet will tell you at your accounting date everything that your business owns and everything that your business owes.  Examples of asset accounts will be cash at bank, premises that the business owns, any equipment, motor vehicles and any money that’s owed to you by customers. Liabilities could be be bank overdrafts, bank or finance company loans or what you owe suppliers or customs and revenue. The balance sheet will summarize all of what you own and what you owe items into one sheet.

What are Management Accounts? 

As your business grows just having your accountant prepare your accounts, your profit and loss account, your balance sheet and your tax return each year is no longer enough. The information that’s contained in your accounting ledger is a really valuable tool to help you keep track of how your business is performing. You could you can use that information to tell you which projects were profitable, which projects were less profitable and if some things are costing you more than you were expecting them to. 

You need to know if you are collecting payments from your customers quickly enough or if you are carrying too much stock (or not enough) so management accounts are prepared for the management of the company to analyse.

This set of financial schedules will often be produced monthly comprising your profit and loss account and your balance sheet, but also drill down more into some of those line items so you can better understand the detail behind your sales, the details behind your costs and your collectibles. It will also show how cash is moving and that information can be used by management to manage the business more efficiently,  understand the businesses current position more and make good timely decisions. 

What is a Cash Flow Statement

Monitoring cash is critical to a business. If cash runs out employees and suppliers can’t be paid and a business can fail, and although it sounds ironic even profitable businesses can can run out of cash if they don’t manage it correctly. If a business is working on a very big project that is that is quite lengthy in duration and and most of it is paid at the end then the business is going to be paying out for for materials wages and services for many months before receiving any income, and that’s when a profitable business can run into difficulty. So it is critical to monitor cash as well as sales and profits because often they are out of step with one another. What a cash flow statement is doing is monitoring the actual cash that is coming in and out of in and out of the doors of your business because whilst you’ve recorded a sale, your customer may not have paid you, that might still be in receivables in your balance sheet on a cash flow statement. You will only see revenue from customers when that cash has actually been received, so what a cash flow statement is doing is showing you the reality of cash in and out of your business so that you can closely monitor it, anticipate what is happening and what’s going to happen. This provides management the opportunity to make good timely arrangements with banks and lenders if necessary to ensure their business can run smoothly through the peaks and troughs of normal business activity.

What is EBIT and EBITDA

EBIT is Earnings Before Interest and Tax, so that is that is profit before any interest or tax payments have gone out and typically that is a popular measure because it’s considered in many ways to be a fairer representation of how well a business has performed and how good a job management are doing. This  because arguably interest rates are outside of the control of management or in the case of taxes, the better you do the higher your tax bill is likely to be. So earnings before interest and tax is a good measure of how well management have done.

EBITDA is progression of this in so far that is earnings before interest and taxation again but also depreciation and amortization. Depreciation and amortization are effectively accounting terms for the reduction in asset values that a business will take over time, but they’re not entries that reflect on cash because you will have bought your asset. For example,  you would have bought your company vehicle perhaps five years ago and the value of that vehicle will be spread over over the life of it, so whilst all the cash went out on day one perhaps you would depreciate the vehicle over five years. You would take a depreciation charge every year so where your your profit and loss account will show a depreciation charge reducing your profits, effectively that depreciation isn’t reducing your cash, so what EBITDA does is is adjusts your profit to more closely approximate to cash flow.

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