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Is Your Profit Figure Telling the Truth?

How can you be sure that you allocate costs for your business accounts in such a way that your profit figure is accurate about the state of play? It’s not always clear cut which business costs you should include in your profit and loss account.

Knowing that you’ve got the calculations right is important both for peace of mind, and for satisfying HMRC.

It’s more than just timing

There tend to be two breeds of SMEs when it comes to accounting: the organised on-the-ball SME and the tail-chaser SME. We highly recommend aiming to be the first as it’s easier and saves you an accounting headache in the long run. Nonetheless, both approaches can run in to problems when it comes to entering costs in to their accounts.

The organised SME character who is keen to stay on top of their accounts may simply pop the costs into the month that they paid for them. The tail-chaser may do the same but for different reasons. If this is your default approach then you could be making the mistake of thinking that timing is everything.

While, it’s true that timing is important, it’s for a slightly different reason. Rather than simply inputting the data once you’ve paid for it, you should instead match each cost to the time period that is relevant to that cost.

Let’s look at an example that will be familiar to many SMEs. Say you are putting an advertisement in a trade journal. You decided to run the advertisement in May, and made the payment (and incurred the cost) shortly after. However, the actual benefit to you doesn’t come in May.

Instead, it comes to you when the trade journal is published. This may be a few months later. In this instance, it’s therefore more accurate to record that advertising cost in the month that the publication went live.

This results in a couple of key ways for ensuring you create accurate accounts.

Prepayments and accruals – managing costs

As we’ve seen in the trade journal example above, in the event that you pay for a cost in advance then you should wait to put that cost in the relevant time period. This is what’s known as a prepayment.

An alternative accounting situation arises for costs that you pay after the event. Here you need to do the converse of what you do with pre-payment by allocating the cost to the past time period in which it was relevant. This is an accrual.

This to-and-fro approach may seem slightly more complicated, but it’s more accurate for getting a profit figure which gives an accurate picture. The good news is that if you use cloud accounting software then this quickly becomes a straight-forward part of keeping on top of your accounts.

Looking at your costs

It’s good practice to look at your costs carefully. However, many SMEs don’t do it as frequently as they should. If you only look in detail at your costs annually then you don’t get a clear picture of your profit and loss over the year. If, on the other hand, you do review them monthly or at most, quarterly, then you can see what’s happening with your profit and loss more instantaneously.

This is a really important concept to grasp. Understanding your profit and loss account is not simply a case of looking at what is going in and out of your business bank account. Understanding this allows more accurate future planning and decisions.

 

Do you need help managing your profit figure? Signing up to a cloud based software such as Pandle can help you make short work of your profit and loss accounts. Sign up for a free account today!