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Jargon Busting - 4 Accountancy Words You Wish You Understood
Are there some basic accountancy words you don't quite understand? Would you like to know a bit more to help understand your figures and your accountant?
Here's a handy initial list of 4 words to start you off:
1. Turnover. Well this is really Sales but Sales seem to refer more to Goods. Turnover includes all sorts of Sales such as Services as well as Goods, but essentially it really means Sales! The amount of Turnover is the total of all the Invoices you've issued before VAT. So, you might not yet have been paid for these Sales. It has nothing to do with VAT.
2. Profit/(Loss). This starts with Turnover, but you then deduct all the costs that related to that Turnover. For example, Salaries or Rent for the months that generated that Turnover. Again, this has nothing to do with VAT - this is ignored (usually!). Plus accountants add a couple of other pretend costs such as Depreciation - see 3. If after all these costs there's a positive figure eg £100, then you've made a Profit. If it's a negative figure eg -£100, then you've made a Loss. This is not necessarily bad, especially for a start up, as a certain amount of investment in your new business is necessary and desirable.
3. Depreciation. This is one of those accountancy pretend costs that are needed to get to your most accurate Profit or Loss figure. If you ignore it, your Profit would be too high or your Loss too low. It's an indication of how much of an asset you've had to use to generate your Turnover eg if expensive computer equipment costing £6k should last you 3 years, you might spread that cost over 3 years and deduct a non-cash 'pretend' cost of £2k per year.
4. Cashflow. This ignores things like Invoice dates and Depreciation and is only concerned with money actually coming in and going out; the 'flow' of money. So not only does it include the amounts you've charged and been paid, included in your Turnover, it also includes the VAT added on to your charges showing on your Invoices. Similarly, where you've paid for something, it includes the VAT you paid on those costs.
You can see therefore that if your customers take time to pay you, you may run out of cash even if you're making a Profit. This is a common problem, especially for start-ups and growing businesses, so that many businesses fail just from running out of cash. Preparing a rough expected future cashflow (Forecast) should keep things under control.