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Accounting Tips for Small Businesses – UK Version

May 26, 2024 | Business, UK Accounting

If you are a business owner or have plans to start one, keeping track of all your financial activities right from the start is essential.

We’re sure you wouldn’t want your business to fail due to a lack of accurate finances. Hence, you should ensure proper recording of your business transactions.

This process is just part of “accounting,” a term that you may have already come across but haven’t fully understood yet.

There are many principles and standards to follow in accounting for business, but we will make it easy for you. Learn Accounting Tips for Small Businesses by reading the whole blog.

Accounting Tips for Small Businesses: Accounting Tips for Small Businesses in the UK

Accounting Tips for Small Businesses: Accounting Defined

It is vital to understand the definition of accounting to learn Accounting Tips for Small Businesses. 

Accounting is the process of recording, classifying, and summarising financial transactions to provide meaningful financial information to various stakeholders, such as business owners, investors, creditors, and regulatory agencies.

Entrepreneurs need to know what accounting is since it plays a critical role in the management and control of the financial resources of their business, as well as in compliance with legal and regulatory requirements.

It also provides insights into the business’s financial health, which can be used to guide strategic decision-making, assess risk, and improve overall performance.

Accounting Tips for Small Businesses: The Basic Accounting Equation

The accounting equation is one of the fundamental accounting principles that every business owner should understand. It is the foundation of accurate bookkeeping and accounting of your business.

This principle states that the Total Assets should always be equal to the Total Liabilities and Equity. It helps track the Balance Sheet, one of the financial accounts.

Assets

Assets are economic resources that a business owns or controls and are expected to provide future financial benefit to the company (e.g., an increase in revenue or reduction in costs).

Examples of assets in a business are cash, accounts receivable (due from customers), inventory, prepaid expenses, buildings, land, equipment, etc.

Liabilities

Liabilities represent the financial obligations that a business owes to others. These obligations arise from past transactions or events and must be settled by making payments or providing goods or services in the future.

Liabilities include accounts payable (due to suppliers), loans payable, unearned revenue (revenue to be rendered in the future), and other provisions and contingencies.

Equity

Equity refers to the residual interest in the assets of a business after deducting liabilities. In other words, equity represents the ownership interest in a business that remains after all debts and other obligations have been paid off.

It can also be computed by getting the changes in equity (i.e., increase in capital contribution and net income generated) and reflecting it to the beginning balance of the equity account.

Accounting Tips for Small Businesses: The Accounting Process

It is equally important in learning the Accounting Tips for Small Businesses to be familiar with the accounting process for their business activities.

The accounting process involves a series of steps used to record, track and report the financial transactions of a business. Below is an outline with brief descriptions:

  1. Record transactions. Identify, classify, and record financial information in a journal.
  2. Update the general ledger. Transfer journal entries to the general ledger.
  3. Check the trial balance. Verify debits as equal credits.
  4. Adjust entries. Make changes to accounts to reflect correct balances.
  5. Check the adjusted trial balance. Verify that debits still equal credits after adjustments.
  6. Prepare financial accounts. Financial statements, such as the income statement, balance sheet, and cash flow statement, are prepared using the information from the adjusted trial balance.
  7. Close temporary accounts. Zero out balances of temporary accounts and transfer to capital to update its balance.
  8. Check the post-closing trial balance. Verify that all accounts are up-to-date and balanced after the closing entries.
  9. Make reversing entries (optional). Some accountants make reversing entries at the beginning of the next accounting period to simplify the accounting process and ensure accuracy.
  10. Start a new accounting period. Begin a new accounting cycle to record future transactions.

Accounting Tips for Small Businesses: The Financial Accounts

Financial accounts are reports that summarise a business’s financial activities and position over a specific period.

These should be prepared in accordance with the International Financial Reporting Standards (IFRS) and New UK Generally Accepted Accounting Practice (GAAP).

Small businesses in the UK have the option to report only “abridged accounts” to simplify things and have less information to provide to Companies House and HM Revenue and Customs.

But for better understanding, the leading financial accounts are described below:

Accounting Tips for Small Businesses: Income Statement

Also known as the profit and loss statement (P&L), the income statement reports a business’s revenues, expenses, gains, and losses over a specific period (typically one year). 

The net income or net loss is calculated by subtracting the total expenses from the total revenues. Remember that when the resulting number is positive, it is a profit; if negative, it is a loss.

Accounting Tips for Small Businesses: Balance Sheet

The balance sheet provides the status of a business’s financial position at a specific point in time. It lists the business’s assets, liabilities, and equity. The total assets must always equal the sum of the liabilities and equity.

Accounting Tips for Small Businesses: Cash Flow Statement

A cash flow statement is a report showing how much cash the business has coming in and going out over a specific period.

Its purpose is to provide report users with a better understanding of the cash position and the ability of the business to generate and use cash.

The cash flow statement typically includes three sections:

  1. Operating activities. This usually composes of sales and expenses transactions.
  2. Investing activities. Typical transactions under this are buying or selling property, investment shares to other entities, and corresponding dividends received.
  3. Financing activities. This includes transactions related to borrowing money or paying dividends to investors.

Accounting Tips for Small Businesses: Accounting Ratios for Analysis

Several ratios can be calculated from a balance sheet and an income statement.

These ratios add value to learning the Accounting Tips for Small Businesses as these provide insights into the financial health and performance of a business. Here are some of the most commonly used ratios:

  1. Current ratio. This ratio compares current assets to current liabilities and indicates whether the business has enough short-term assets to cover its short-term liabilities.
  2. Quick ratio. Similar to the current ratio, the numerator only includes the most liquid assets (such as cash, marketable securities, and accounts receivable).
  3. Debt-to-equity ratio. This ratio compares total debt to its equity and indicates the extent to which the business is financing its operations with debt instead of equity.
  4. Return on equity (ROE). This ratio measures profitability by comparing its net income to its total equity.
  5. Gross profit margin. This ratio indicates how much of each sales dollar is left over after accounting for the cost of goods sold.
  6. Net profit margin. This ratio measures overall profitability by comparing its net income to its total revenue.
  7. Inventory turnover. This ratio indicates how quickly a business sells its inventory by comparing its cost of goods sold to its average inventory.
  8. Accounts receivable turnover. This ratio indicates how quickly a business collects its accounts receivable by comparing its total credit sales to its average accounts receivable balance.

These are just a few examples of the ratios that can be calculated from the financial accounts, which can best be read alongside other financial metrics and qualitative factors when assessing the business’s finances.

Frequently Asked Questions

What is the difference between bookkeeping and accounting?

Bookkeeping and accounting are two closely related but distinct fields.

Bookkeeping involves the recording of financial transactions, such as purchases, sales, receipts, and payments, while accounting focuses on the analysis, interpretation, and presentation of financial information.

Bookkeeping is an essential piece of the puzzle, and accounting is the bigger picture that requires a broader range of skills and responsibilities.

What is the difference between cash and accrual basis of accounting?

Cash accounting records transactions when cash is received or paid out, while accrual accounting records transactions when they occur, regardless of when cash is received or paid out.

In the UK, small businesses can choose to use either the cash basis or the accrual basis for their accounting. Cash basis accounting is best suitable for small businesses with a turnover of less than £150,000 annually.

The accrual basis is more complex and is preferred for larger businesses or those with inventory or accounts payable/receivable.

It’s important to note that the choice of Accounting Tips for Small Businesses can affect a business’s tax liability, so it’s recommended to consult an accountant or tax advisor to determine which method is best for your business.

Do small businesses need to hire an accountant?

Accounting Tips for Small Businesses don’t necessarily need to hire an accountant. Still, working with an accountant or bookkeeper is recommended to ensure accurate financial reporting.

Accountants are especially useful for businesses to get advice on tax and financial matters.

Conclusion

No matter how busy entrepreneurs can be, they should provide a little time to understand how basic accounting works. This will help them better grasp the business’s finances and tax obligations and guide them to make sound financial decisions on a solid basis.

If you want to get help on accounting for your business, check out Sterlinx Global.

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