Financial planning and budgeting are essential for any organisation, regardless of its scale. Whether you are running a household, a small business, or a large corporation, planning, budgeting, monitoring, and taking corrective action are pivotal to ensuring that you are on the right track in pursuing your goals. This is one of the major reasons why the process of maintaining and publishing annual accounts is critical for any business entity.
In this article, we will delve into the meaning of annual accounts, the major types of annual accounts, and the essential components of said accounts.
What is meant by annual accounts?
The simplest way to define annual accounts is that they are a series of documents comprising the financial and operational information pertaining to a business over the course of a one-year period. Every transaction that a business engages in is recorded in the books of accounts, which are, in turn, summarised on a monthly and yearly basis, yielding the annual accounts or financial statements of said business.
Annual accounts are prepared to assess and analyse the financial and operational performance of an organisation during a particular accounting year. Such financial statements shed light on the profitability, solvency, and overall operational efficiency of a business. They also present a clear picture of an organisation's assets and liabilities, and shareholding patterns.
In addition to helping businesses gauge the level of adherence to plans, annual accounts are also pivotal for external stakeholders. Various accounting ratios are computed on the basis of the annual accounts of an organisation, and these ratios serve as important metrics for existing and prospective stakeholders alike. Furthermore, preparing and auditing annual accounts is critical from a compliance point of view, including the discharge of a business's tax liability.
Major types of annual accounts
There are several annual accounts that an organisation, particularly a company, is required to maintain. Amongst the key types of annual accounts are an income statement, which is also referred to as a profit and loss account, a cash flow statement, and a balance sheet. In this section, we shall briefly discuss each of these accounts.
1. Profit and Loss Account: As its name suggests, a profit and loss account is a comprehensive financial statement containing an organisation's revenues and expenses over a particular period (usually one year). This account yields information about the various profitability metrics of an organisation, including gross profit, operating profit, and net profit.
Amongst the major heads of expenses recorded in an income statement are:
- Cost of goods sold (computed from the trading account)
- Administrative expenses
- Marketing expenses
- Salary expenses
- Interest expenses
- Depreciation
The major types of revenues recorded in a Profit and Loss Account are:
- Sales revenue
- Interest earned
- Commission earned
- Rental income, etc.
In addition to shedding light on the profitability of an organisation, a profit and loss account also has other uses. The income statements for different years can be used to establish the profitability patterns of the organisation over a long period. Furthermore, patterns can be established vis-a-vis the growth or decline in sales and other heads of revenue and expenses. Several important accounting ratios can be computed with the information resulting from a profit and loss account, including gross margin, operating ratio, and net profit ratio.
2. Balance Sheet: Another key annual account created by organisations is a balance sheet; this financial statement presents a glimpse of the assets and liabilities of a business on a particular date (usually the last date of the accounting year). A balance sheet also includes mention of a company's shareholders’ equity, thereby shedding light on its ownership structure.
A balance sheet has two sides, one each to depict the assets and liabilities of an organisation. The common heads for assets in a business's balance sheet are:
- Cash and cash equivalents
- Capital assets (including plant and equipment)
- Inventory
- Accounts receivable (including debtors)
- Investments
- Intangible assets (including patents)
- Prepaid expenses
- Accrued incomes
Here are the major components of the liabilities side on a business's balance sheet:
- Current liabilities (including short-term debt)
- Outstanding long-term debt
- Shareholders’ equity
- Retained earnings
The balance sheet of a company is a critical annual account that is used by various stakeholders. It is a snapshot of the company's financial position as on a specific date, and pivotal to the computation of key accounting ratios such as current ratio, quick ratio, debt to equity ratio, return on assets ratio, and return on equity ratio.
3. Cash Flow Statement: The third major type of annual account for any organisation is a cash flow statement. Such a statement is an extensive account of the flow of cash to and from the organisation. A cash flow statement usually contains three major sections, namely cash from operating activities, cash from investing activities, and cash from financing activities. Let us briefly discuss each of these.
- Cash from operating activities: This section of a cash flow statement contains the description of cash used in and generated from the primary operating activities of a business. Such activities include, among others, the revenue generated from the sale of products and (or) services as well as expenses such as purchase of goods and payment of salaries.
- Cash from investing activities: This part of a cash flow statement is centred around the cash used in and generated from the investing activities undertaken by an organisation. Cash outflows recorded in this section include the purchase of any capital asset or any long-term investment. On the other hand, cash inflows include the sale of capital assets and investments.
- Cash from financing activities: This section of a cash flow statement sheds light on the cash that is generated from and used towards financing a business. The primary sources of cash included in the section are the issuance of share capital and raising debt. Cash outflows covered under this section include repayment of debt, repurchase of share capital, payment of dividends, etc.
To sum it up
All the annual accounts of a company are important because they present a clear picture of the company's financial position, including its profitability, ownership structure, reliance on debt, and cash flow strength. The study of a company's annual accounts can help you gain significant insights about the company.
