Understanding Business Accounting For Dummies, 2nd Edition (3 page)

Introduction

W
elcome to
Understanding Business
Accounting For Dummies
. We've written this book for people who need to understand accounting information and financial reports -
not
for accountants and bookkeepers (although they should find this book very interesting and a good refresher course). This book is for people who need to use and understand accounting information - business managers and entrepreneurs, for example, who need to make profit, turn profit into cash flow, and control the assets and liabilities of their business. If you're running a business or you're a business unit manager, we're probably preaching to the converted when we say that you need a basic familiarity with accounting and financial statements in order to make good business decisions.

Business investors, lawyers, business consultants - pretty much anyone who reads (or aspires to read)
The Financial Times
- can also benefit from a solid understanding of how to read financial reports and how accounting works.

About This Book

Understanding Business Accounting For Dummies
lifts the veil of obscure terminology and lays bare the methods of accounting. This book takes you behind the scenes and explains the language and methods of accounting in a down-to-earth and light-hearted manner - and
in plain English
.

Each chapter in this book is designed to stand on its own. Each chapter is self-contained, and you can jump from chapter to chapter as you please (although we encourage you to take a quick tour through the chapters in the order that we present them). We bet you'll discover some points that you may not have expected to find in a book about accounting.

Conventions Used in Financial Reports

Much of this book focuses on profit and how a business makes profit. Because profit and other financial aspects of a business are reported in
financial statements
, understanding some basic notations and conventions used in these financial reports is important.

We use the following condensed profit and loss account to illustrate some conventions that you can expect to see when reading financial reports. (The actual format of a profit and loss account includes more information about expenses and profit.) These conventions are the common ways of showing figures in financial reports just as saying hello and shaking hands are common conventions that you can expect when you greet someone.

Abbreviated Profit and Loss Account

Sales revenue £25,000,000

Cost of goods
15,000,000
sold expense

Gross margin £10,000,000

Marketing expenses £4,000,000

Other expenses
2,000,000
6,000,000

Profit
£4,000,000

You read a financial statement from the top down. In this sample profit and loss account, for example, sales revenue is listed first followed by cost of goods sold expense because this particular expense is the first expense deducted from sales revenue. The other two expenses are listed below the first profit line, which is called gross margin.

The sample profit and loss account includes two columns of numbers. Note that the 6,000,000 total of the two expenses in the left column is entered in the right column. Some financial statements display all figures in a single column.

An amount that is deducted from another amount - like cost of goods sold expense in this sample profit and loss account - may have parentheses around the amount to indicate that it is being subtracted from the amount just above it. Or, financial statements may make the assumption that you know that expenses are deducted from sales revenue - so no parentheses are put around the number.
You see expenses presented both ways in financial reports. But you hardly ever see a minus or negative sign in front of expenses - it's just not done.

Notice the use of pound signs in the sample profit and loss account. Not all numbers have a pound sign in front of the number. Financial reporting practices vary on this matter. We prefer to use pound signs only for the first number in a column and for a calculated number. In some financial reports, pound signs are put in front of all numbers, but usually they aren't.

To indicate that a calculation is being done, a single underline is drawn under the bottom number, as you see below the
15,000,000
cost of goods sold expense number in the sample profit and loss account.

The final number in a column is usually double underlined, as you can see for the £4,000,000 profit number in the sample profit and loss account. This is about as carried away as accountants get in their work - a double underline. Again, actual financial reporting practices are not completely uniform on this point - instead of a double underline on a bottom-line number, the number may appear in
bold.

Sometimes statements note that the amounts shown are in thousands (this prevents clogging up neat little columns with loads of noughts). So if a statement noting ‘amounts in thousands' shows £300, it actually means £300,000. And that can make quite a difference!

When we present an accounting formula that shows how financial numbers are computed, we show the formula in a different font with a grey screen, like this:

Assets = Liabilities + Owners' Equity

Terminology in financial reporting is reasonably uniform, thank goodness, although you may see a fair amount of jargon. When we introduce a new term in this book, we show the term in
italics
and flag it with an icon (see the section ‘Icons Used in This Book' later in this Introduction). You can also turn to Appendix A to look up a term that you're unfamiliar with.