Understanding the Accounts – A Beginner’s Guide

Financial statements are important for understanding a company’s financial health. In the UK, they follow strict rules, often based on International Financial Reporting Standards (IFRS).

This can make them look a bit confusing if you’re not used to them.  But have no fear – for beginners, this guide will help you understand the basic parts of a company’s financial reports.

And at the end we’ve put some key tips that will help you get started.

Key Components of UK Financial Statements

1. Income Statement (Profit and Loss Account):
   The income statement shows a company’s revenue, costs, and profits over a period, usually a year. It tells you how much money the company made, its expenses, and whether it had a profit or loss.
   • Revenue: The total money the company earns from selling goods or services.
   • Cost of Goods Sold (COGS): The direct costs to produce those goods or services.
   • Gross Profit: This is revenue minus COGS. It shows how efficient the company is at making its products.
   • Operating Expenses: Costs not tied directly to production, like rent, salaries, and utilities.
   • Net Profit: The profit left after all expenses, taxes, and interest are paid.

The income statement is useful for seeing if a company is making money and how its expenses compare to income over time.

1. Balance Sheet (Statement of Financial Position):
   The balance sheet provides a snapshot of a company’s financial position at a specific time. It lists what the company owns (assets), what it owes (liabilities), and the shareholders’ equity.
   • Assets: Resources owned by the company. These include:
     • Current Assets: Cash, inventory, and receivables, which will be used or turned into cash within a year.
     • Non-Current Assets (or ‘Fixed Assets’): Long-term assets like property, equipment, and investments.
   • Liabilities: The company’s debts and obligations. These include:
     • Current Liabilities: Debts due within a year, like accounts payable or taxes.
     • Non-Current Liabilities: Long-term debts, such as loans that are due after more than a year.
   • Equity: The value left after subtracting liabilities from assets. It shows the owners’ share in the company.

The balance sheet is key to understanding a company’s stability. It helps you see if the company has enough assets to cover its debts and how much of the company is financed by debt.

Financial Ratios

To understand the data better, financial ratios break down the numbers into simple indicators. These ratios are useful for evaluating a company’s performance.

• Profitability Ratios: These help assess how profitable a company is. For example, the net profit margin shows how much profit the company makes for each pound of revenue.
• Liquidity Ratios: These ratios show if a company can pay off its short-term debts. The current ratio compares current assets to current liabilities. A ratio above 1 means the company can cover its debts.
• Leverage Ratios: These ratios indicate how much the company relies on debt. The debt-to-equity ratio shows how much debt the company has compared to equity. A high ratio means the company uses more borrowed money, which can be risky.

The Importance of Notes to the Financial Statements

Financial statements come with detailed notes. These notes explain the numbers in more detail and provide important context. For example, the notes explain accounting policies, break down complex figures like debt or taxes, and highlight risks. They also give information on any significant events or changes in the company’s operations.

The notes are essential for understanding the financial health of the company. Always check them to see what’s behind the main numbers.

Legal Requirements

In the UK, companies must file financial statements with Companies House every year. They need to follow the rules in the Companies Act 2006. Smaller companies have simpler requirements, but all must ensure their reports give a “true and fair” view of their finances.

Tips for Beginners

1. Start with the Income Statement: Look at the company’s revenue and profit. Compare the trends over time.
2. Study the Balance Sheet: Check if the company has enough assets to cover its liabilities. Also, see how much debt it has.
3. Read the Notes: The notes explain details that are not immediately clear from the statements. They provide essential context.

By focusing on these main parts, you can gain a clear understanding of a company’s financial health. Over time, as you get more familiar with these statements, it will be easier to analyse and interpret the information.

As always, if you need any help then please get in touch with us on 01634 540040 or email andy@aktax.co.uk.