Are you a construction business owner who feels a bit lost in the accounting terms when it comes to a meeting with your accountant?
In this video, I will explain everything or scroll down to read below.
Assets
Assets within your business are defined in two areas: fixed assets and current assets.
You can physically own, touch and feel a fixed or non-current asset. For the construction business, these are likely to be plants and machinery that will last more than one year. It would also be vehicles which could be vans and cars, it could be buildings, and it could also be furniture and fittings which are within your office. All of these are defined as being large items and would last more than one year.
Other assets in your business are known as current assets; these can be a variety of things; the big one is normally accounts receivable. This is what you’ve invoiced to your customers but have not yet been paid for; this is recorded on your balance sheet as a current asset.
Other assets within your business could be prepayments; from an accounting perspective, the cost is recognised when we receive the invoice, but this could be paid in advance. A classic example of this insurance,
you pay for your insurance a year upfront, but this straddles your year-end; you will have to carry forward some of that cost against the following year.
Cash in the bank is also considered as a current asset.
Liabilities
This is everything that the company owes to various people or organisations.
We can classify these into two areas:
- Current liabilities, which means that this liability is payable in less than 12 months,
- Long-term liability is payable beyond 12 months.
current liabilities
Normally the big ones within current liabilities are accounts payable; this is also known as trade creditors. In the accounts, we recognise a cost on an invoice basis. Now, if you’ve got that on credit terms, which could be 30, 60, or 90 days, whatever you negotiate, this will be sitting there as a liability on your balance sheet as the money has not left your bank account.
This is a great way of helping with your cash flow, and any money that is owed to your suppliers is interest-free. Make sure that you are using this to its optimum as it’s cheap money.
long term liabilities
Long-term liabilities will be a mortgage, or if you’ve got a loan which is payable over more than one year.
Another account as well, which is commonly referred to as a long-term liability, is money you’ve invested in the company that sitting in your Directors Loan Account. So, if you’ve got a big credit balance, which means, in layman’s terms, the company owes you money, you have an opportunity to classify this under or over one year.
A lot of businesses we work with sometimes have big credits in their Director’s Loan Account, and we’ll classify these over one year because they expect to get it in 2-, 3-, or 4 years’ time.
But this is a judgement that you’ve got when you sit down and talk with your accountant.
Balance Sheet
In layman’s terms, a balance sheet is where you take a picture of all your assets and liabilities at that given time. So if you’re doing a balance sheet as of the 31st of December, it will have every asset and every liability showing the net worth of your business. And just remember that costs and income are recognised when invoices are received and posted onto your system, not when it’s paid out of the bank.
The true reflection of how well a company is doing and how well it has done in the future will be its closing balance sheet because it will show black holes and problem areas within a business, especially if it’s undercapitalized.
income statement or profit loss account
This is income, less costs which we normally define as direct costs and overheads equal profit. When I was training, we always referred to it as our profit loss account, but now we’ve implemented international standards, and It’s known as an income statement.
They are a scoreboard of how well your business is doing in the year from a profit basis.
A lot of people can hide behind various numbers that, “Oh, my turnover is brilliant,” but yeah, that’s all good, but you’re in business to create value and make money; a high turnover does not guarantee profitability. So your income statement or profit loss account tells you exactly how well you’re doing for that year.
From a management account perspective, having shorter income statements for a period is possible. But when you’re looking at a standard company set of accounts, this is on a 12-month basis.
One thing to be mindful of as well, if you’re comparing data, which you should always do, is to be careful that you’re comparing 12 months with 12 months because it’s easy for a company to change the year-end.
depreciation
Earlier here, I mentioned fixed assets, defined as something significant in value that will last more than one year.
The example I will use is a computer; if you buy a laptop, that will be a physical asset for the company. The laptop cost is £1200, and I would generally classify this as would last three years.
For depreciation, you break down the cost over three years. By a straight-line depreciation method, this will be a third each year. So, £400 will go into your profit loss account for that year; that £400 will go down as an expense which reduces your profit, and the other side of the £400 would reduce your assets that sit in the balance sheet.
So by the time you get to its useful life, you’re expected to be knackered and trade it in for a new one, and the balance should be 0 in your accounts.
It’s not an exact science; it’s your best guess estimate. But depreciation is taking an asset sitting on your balance sheet in fixed assets and reducing it to its useful life.
A planning point, especially for construction businesses, is to be mindful of when your assets need replacing because plant machinery tools are capital-intensive. So, remember when you’ve got renewals because you need to make sure that investment is in your business, and you will need the cash flow to fund it.
I hope this article helped, and if I could further help, I offer you a free discovery call.
We can either chat on the phone or via Zoom, and I’ll take on board any questions you have, and I promise there’ll be no pushy sales pitch.
