Understanding Accounting from A to Z

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Understanding accountancy is like driving a car:
It fills most people with dread and fear. But once they’ve had a bit of experience, it becomes second nature and they wonder what all the fuss was about. They probably even start to do it without thinking (just as drivers instinctively change gears etc).

What is Accounting?

Accountancy is about identifying and recording, analysing and explaining, the financial implications of business transactions and decisions to enable businessmen to understand the performance of their businesses, and to help them make decisions and take actions which assist in achieving the objectives of the business.

But don’t worry, as I will explain over the next few pages, it’s actually really rather simple!

Types of accounts

Just as there are several different types of accountants, there are also many different types of accounts. However they can be grouped under two main headings:

Financial accounts – for limited companies these are sometimes also known as statutory accounts; and Management accounts

(1) Financial accounts
These are compulsory for companies, and must be sent every year to the shareholders in your company and to Registrar of Companies (“ROC”). In addition:

They must follow a standard set of rules and conventions, and show what went on during the financial year; and

They are mainly used by people outside your business – eg bankers, customers, suppliers and, of course, the tax person.

Sole traders and partnerships must also produce financial accounts – although they do not need to be sent to ROC and there are not so many rules governing how they must be set out and what they must contain.

(2) Management accounts
This type of accounts are essential for well-run businesses, but are not strictly required by law. As their name suggests, management accounts are mainly used by management. In fact it is very rare for them to be shown to anybody outside the business – and businesses cannot usually be forced to show their management accounts to anyone other than their auditors and (in exceptional cases) the tax person.

There are no rules that say what management accounts must look like – it is up to each business to decide what format will best help it to understand what is going on, control the business and make better decisions

Management accounts often predict the future as well as keep track of the past i.e. they usually include forecasts of what is going to happen tomorrow as well as recording what happened yesterday. In contrast, financial accounts only ever record what has already happened in the past.

Your books
Both sets of accounts (management & financial) use the same basic information which they get from the same place – the company’s “books”. We shall describe what type of books you will need to keep later in these notes. However first we shall look at your accounts themselves.