Financial and management accounts: the basics

Introduction

The accounting needs of your business will vary according to its size, type and sector. As the business owner, it's your
responsibility to make sure your business keeps accurate records and accounts.
There are two types of accounting information - financial accounts and management accounts.
Financial accounts describe the performance of your business and have to be filed at Companies House - or Companies
Registry for businesses in Northern Ireland. Management accounts are aimed at helping you to plan your business and
make decisions about key areas such as sales, margins and stock.
This guide will explain the basics of both types of accounts and what they should include. It outlines your financial
accounting obligations as well as how management accounting can help you run your business more effectively.
Financial accounts
Financial accounts are an historical record of your business' performance over a past period - usually one year - for
the benefit of external users such as shareholders, employees, suppliers, bankers, tax authorities and, for larger
companies, consumer groups.
A "summary financial statement" can be issued to the shareholders of listed companies - this summarises the information
contained in a company's annual account and directors' report. Public companies usually communicate their accounts to
their shareholders in the form of an annual report, which also contains a management overview of the company's
performance. Regulations allow all companies to distribute summary financial statements, including those which have
accounts prepared under International Accounting Standards.
Financial accounts normally include the following elements.
Profit and loss account
This measures your business' performance over a given period of time, usually one year.
It compares the income of your business against the cost of goods or services and expenses incurred in earning that
revenue. See our guide on how to set up a simple profit and loss account for your business.
Balance sheet
This is a snapshot of your business' assets (what you own or are owed) and your liabilities (what you owe) on a particular
day - eg the last day of your financial year. See our guide on balance sheets: the basics.
Cashflow statement
This shows how your business has generated and disposed of cash and liquid funds during the period under review. A
cashflow statement is different from a cashflow forecast, which is used to predict the expected rises and falls in cashflow
over the coming year. See our guide on cashflow management: the basics.
Statement of recognised gains and losses
This records all gains and losses since the previous set of accounts. For example, changes caused by currency
fluctuations, property revaluation, profits earned by associates and joint ventures not included in the normal accounts.
Cashflow statement
This shows how your business has generated and disposed of cash and liquid funds during the period under review. A
cashflow statement is different from a cashflow forecast, which is used to predict the expected rises and falls in cashflow
over the coming year. See our guide on cashflow management: the basics.

Statement of recognised gains and losses

This records all gains and losses since the previous set of accounts. For example, changes caused by currency
fluctuations, property revaluation, profits earned by associates and joint ventures not included in the normal accounts.
Unincorporated businesses
Unincorporated businesses such as sole traders and partnerships are required by HM Revenue & Customs (HMRC) to
maintain proper books and records to support annual income tax returns. These must be kept for a minimum of six
years. See our guide on how to set up a basic record-keeping system.
Filing financial accounts
Limited companies are obliged by law to prepare a set of financial accounts each year and publish them by filing a copy
with Companies House.
You must file accounts within 22 months of your business' formation, and thereafter within ten months of each financial
year end..
Small companies
A small company is one which meets at least two of the following criteria:

annual turnover must be 5.6 million or less

the balance sheet total - fixed and current assets - must be 2.8 million or less

the average number of employees must not exceed 50

Small companies must deliver the following to Companies House:

abbreviated balance sheet and notes

special auditors' report - unless the company has a small company audit exemption

Medium companies
A medium-sized company must meet at least two of the following criteria:

annual turnover must not exceed 22.8 million

the balance sheet total must not exceed 11.4 million

the average number of employees must not exceed 250

Medium-sized companies must deliver the following to Companies House:

full balance sheet

abbreviated profit and loss account

special auditors' report

directors' report

Management accounts
Management accounts are invaluable in helping you to make timely and meaningful management decisions about your
business.
Different businesses will have different management accounting needs, depending on the business areas that are
important to them. These can include:

the sales process - including pricing, distribution and debtors

the purchasing process - including stock records and creditors

a fixed asset register

employee records

There is no legal requirement to prepare management accounts, but it is hard to run a business effectively without them.
Most companies produce them regularly - eg monthly or quarterly.
Management accounts analyse recent historical performance and usually include forward-looking elements such as
sales, cashflow and profit forecasts. The analysis is usually performed against forecasts and budgets that have been
produced at the start of the year. See our guide on budgeting and business planning.
The information in management accounts is usually broken down so that the performance of different elements of the
business can be measured. For example if a business has more than one sales outlet, there might be a separate report
for each. There may also be a report produced to show how well a particular product has done across different outlets.
For businesses selling more than one product, it is advisable to provide a financial breakdown for each product category.
This will allow you to ensure that profitable products are not subsidising those that are selling poorly, unless you
intentionally promote loss leaders to attract further custom.
Uses of management accounting
Management accounts will enable you to:

compare your accounts with original budgets or forecasts

better manage your resources

identify trends in your business

highlight variations in your income or spending which may require attention

They should be used for the following:

Record keeping

recording business transactions

measuring results of financial changes

projecting financial effects of future transactions

preparing internal reports in a user-friendly format

Planning and control

collecting cash

controlling stocks

controlling expenses

co-ordination and monitoring of strategy/performance

Decision making

using cost information for pricing, capital investment and marketing

evaluating market and product profitability

evaluating the financial effect of strategies and plans

Analytical accounting tools

Analysing financial accounts enables you to compare the company's performance against previous years and with its
competitors.
Ratios enable you to quickly see the relative value of one thing against another, eg two items on the balance sheet.

Ratio analysis can also be applied to non-financial data. For ease of reference, ratios are often split into the following
areas of common control.

Liquidity ratios

These ratios are used to measure solvency and short-term survival prospects.

Capital structure ratios

These ratios measure the adequacy of owners' funding in relation to long-term debt.

Activity and efficiency

These ratios measure the operating efficiency of the business in non-financial terms.

ratios

Profitability ratios

These ratios measure overall profitability and how well the business is using its assets and
covering overhead costs.