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In this the final part of 10 things your Accountant needs to know when preparing your accounts I am going to discuss unusual transactions, stock and work in progress and expenditure which is partly business and partly personal.

Have there been any unusual receipts or payments to and from your bank accounts?

Business bank receipts usually consist of money from customers.  Have you paid in any money of your own, if so when and how much, and how have you recorded it in your accounts? Have you banked any loans from friends, family or the bank?  Again your accountant needs to know when, how much and how you have recorded it.  If your accountant is not informed and depending on how your accounts are prepared this money could be incorrectly included in sales.  The money you borrowed from the family, did you make a series of repayments or just one and where did you record them?  These are clearly amounts that should not be shown as a tax deductible expense.

Have you calculated the value of your stock and work in progress to be included in the accounts at the year end?

The value of stock on hand at your financial year end needs to be deducted from the total of your stock purchases for the year to ensure that you only allow for the cost of those products sold to arrive at the correct profit.

How much time has your workforce put into projects before the financial year end that has not yet been invoiced to your customers?  This work in progress needs to be shown as additional income, at the amount you will eventually charge your customers, in your accounts.

Has a proportion of any of your household expenditure been incurred for business purposes?

Do you use your home telephone for business purposes?  If so what proportion of the call costs do you estimate are for business?  Do you have a room at home that you use as an office for the business?  Depending on the amount of time you spend in it running the business a proportion of your household costs can be claimed as a business expense.  The sort of expenses we are talking about are heat and light, rent, rates and, in some cases, mortgage interest.  Do you use your car for business purposes?  If so how many business miles do you travel in a year and what proportion of the total mileage does this amount to.  You can either claim a rate per mile or a proportion of the total cost as a business deduction.

What are the benefits of preparing this information for your accountant?

Firstly your accountant will think that you have much more financial knowledge than the average business owner.  Secondly he may well take substantially less time to prepare your accounts.  Thirdly his bill may be lower than in previous years.  Lastly your accounts will more accurately reflect the profit of the business and, because you have accounted for every relevant expense, your tax bill may also be lower.

In part two of 10 things your accountant needs to know when preparing you accounts I am going to discuss capital equipment, loans, bad debts and accruals.

Have you purchased any Vans, Equipment or Cars during the year?

These items are considered to be capital rather than revenue costs primarily because it will take more than one year to use them up in the process of generating sales. The purchase of equipment should not therefore be shown as an expense within repairs and likewise the purchase of motor vehicles should not appear in the profit and loss account as motor expenses.  Instead both should be shown in the balance sheet under fixed assets.  A proportion of their cost, depending upon their estimated useful life, will be allowed against profit in the accounts each year via depreciation.  All three are treated differently for tax purposes.  There is currently an Annual Investment Allowance of up to £100,000 each year on which 100% of the cost of equipment and vans, but not cars, can be claimed.  Any expenditure above the annual allowance will be written down at 20% per annum within the capital allowances pool.  Cars will also only receive a 20% annual allowance and this may be reduced by any non business use.

Are those loans or leases that you are paying for during the year for which the accounts are being prepared?

It’s very important to know the difference since the repayments are treated differently in the accounts.  Payment for leases lasting less than five years (operating leases) are shown as an expense in the profit and loss account.  Payments for leases of longer than five years (finance leases) are split between the capital repayment element and the interest element.  The former is deducted from the original amount borrowed, as it is paid off, and the latter is included in the profit and loss account as loan interest.  For other loans it’s also important to know how much interest is added to the debt each year in order to provide for this as a tax deductible expense.

Have you incurred any bad debts that need to be recorded in the accounts?

Are there any amounts that you have invoiced to your customers that it doesn’t look like you are going to collect? This could be because the customer has actually gone bankrupt or just because he is not paying you despite promises to the contrary.  You can reclaim the VAT on these amounts as well as claim a tax deduction for the net value of the part of the sale not paid for.  You can also make a general provision for bad debts in the accounts based on, for example, what percentage of your debtors have turned out to be bad in previous years.  This type of provision, however, is not tax deductible and will need to be added back to the profit when your accountant is calculating the tax liability.

Are there any expenses that straddle two years accounts?

Electricity, gas and telephone bills may cover a quarter that is partly within the accounting period under preparation and partly within the next accounting period.  Your accountant will need to see these bills, even though they are dated after the year end, so that he can calculate the relevant proportion of the expenditure.  This is another way of ensuring your tax bill is kept to the minimum.

Whether you are keeping your business records on paper or using accounting software your accountant needs to know the answer to these ten important questions when preparing your businesses accounts.  Why?   Because getting them right will ensure that your accounts will be prepared accurately and your tax bill minimised.  Getting them wrong could lead to larger tax bills because you have not claimed for all of your business expenses.   Worse still, a tax enquiry years later could lead to the discovery of incorrect over claims for expenditure which would result in demands for interest and penalties amounting to thousands of pounds on the underpaid tax.

As the subject of this blog is fairly lengthy it will be posted in three parts, what follows below is part one.

How should Improvements to Business Premises be treated in Accounts?

There have been many tax cases about the difference between a repair and an improvement.  The reason for this is that the cost of a repair can be deducted from income but the cost of an improvement cannot.  It’s not always easy to tell the difference, for example, it used to be that the replacement of single with double glazed windows was classed as an improvement.  Now, since double glazed windows are the norm, it’s considered a repair.  The courts have differentiated between work on an existing chimney, which they class as a repair, and the replacement of one chimney with another in a different place as an improvement.  If an asset is purchased cheaply because it is not in working condition and money is spent to make it work this is classed as an additional cost of purchase not a repair and, for tax purposes , the expenditure is treated in the same way as an improvement .  Small sums are an indication that the expenditure is a repair whereas larger sums are more likely to be improvements.

Have you included Business Expenses Paid personally in your Accounts?

If not your accountant needs to know what they are and how much they amount to.  If any of these are omitted this will lead to overstated profit and therefore a higher tax bill.  The sort of expenditure we are talking about here is, for example, the cost of parking when you visit the bank to pay in business receipts, the cost of subsistence if you are travelling away from your normal place of business, small items of stationery etc.

Have you started factoring your debtors during the period for which the accounts are being prepared?

If you are using a factoring company to collect the money owed by your customers your accountant will need to see their statements.  There are several reasons for this firstly they include the factoring company’s charges.  Secondly, they show the amount of money not yet paid to the factoring company by your customers.  Lastly, they show the balance you have been advanced by the factoring company.  All of these amounts need to be included in your annual accounts.

The simple answer is that profit does not equal cash.  In fact profitable businesses run out of cash and as a result go out of business regularly.

So where is the cash then?

To understand this you need a lesson in how profit is calculated.

The Accruals concept

A transaction is recorded at the time it takes place irrespective of whether money changes hands or not.  You make a sale to your customer and immediately raise an invoice but your customer may not pay you until anywhere between one and three months after this.  You make a purchase from your supplier and receive an invoice on that date but you take advantage of his credit terms paying him thirty days later.

The Matching concept

Revenue is matched with the expenses that generated it.  For example your businesses insurance will normally give you cover for a twelve month period but this may not coincide with the businesses financial year.  It may, for example, start half way so only half of the cost will be relevant to the year.  Electricity is usually billed on a quarterly basis and the quarter may start two months before the businesses year end and end one month after.  To match this expense with the revenue it generated two thirds of it will need to be included in the accounts for the financial year just ended.  The timeline below illustrates this diagrammatically.

The Prudence concept

Liabilities are always taken into account at the earliest point.  Your accountant will include a provision in the accounts for his fees even though you may not get the bill until six months after the year end he is preparing.

Other factors causing a disparity between profit and cash

An increase in sales will increase profit but if your customers are taking longer to pay this will have an adverse effect on your bank balance.  The purchase of a vehicle will have an almost immediate effect on your bank balance even if you are only paying the deposit but the effect on the profit will probably be spread over four or more years via depreciation.  You may have decided to stop selling a particular line and, as the stock gradually reduces, so your bank balance may gradually increase, all other things being equal.

Cash shortage solutions

If you find your business is regularly running short of cash there are ways of countering this and this is not necessarily by increasing overdrafts or taking out loans.  The first thing you should do is to monitor your cash-flow on a daily basis, that way you will begin to see if there is a pattern of cash-flow highs and lows and from there you can find out the causes.  For example, are your sales seasonal and as a result you need larger stock-holdings just before the busy periods? Could you work with your suppliers to bring down the stock levels by obtaining shorter lead in times?  Will your suppliers give you extended credit terms at the time you need to build up your stocks?  Are your customers taking longer to pay or not paying at all?  If so you will need to beef up your debt collection facilities.  In addition you should never grant credit facilities to new customers before you have checked their credit rating.  You could also insist on payment up front for the first few orders.

As you can see there are things you can do without resorting to additional borrowing.

Need help with your cashflow? Call The Really Wicked Accountant.