Why should we do bookkeeping?

Bookkeeping or more accurately ‘business accounting’ is an integral part of the activities of any business and fundamental to it’s success. What is the difference between bookkeeping and business accounting I hear you ask? Well, bookkeeping is technically the recording of transactions relating to a company or organisation. However, recorded information can be used to compile reports which are typically used to make decisions about various aspects of a business. This might include sales, pricing, purchases, costs, growth, investment and so on. The analysis and interpretation of financial data is generally known as ‘financial reporting’. The bookkeeping and financial reporting processes taken together essentially comprise what accounts people refer to as business accounting.

So why is business accounting important to a company, charity or other organisation? Surely it would be a lot easier to just throw away all those annoying receipts, only pay invoices if someone chases them, save money by not employing accounts staff or buying accounts systems and spend more time on the core activities of the business. After all, as individuals we may have an income and various expenses like gas, electricity, water bills and so on but we don’t bother to record every transaction and then analyse the data.

There are in fact good reasons why companies keep business accounting records. For one thing a sole trader or a limited company will have to adhere to government legislation. A business must operate a PAYE scheme if it employs people, it must register for VAT if it’s turnover exceeds a certain limit and it must pay either income tax (sole trader) or corporation tax (limited company) if it makes a profit. As regards the last point about taxation we should note that for a sole trader an individual is the business whereas a limited company is a separate legal entity. Without business accounting the information would simply not be available to compute and pay the various taxes and national insurance that a company is liable to. It must also be able to demonstrate the accuracy of it’s calculations to HMRC in the event of an audit.

OK, we can see the necessity of keeping good accounting records but why go to the trouble of analysing and interpreting financial data? Well, the point here is that financial reporting should not be viewed as an inconvenience to a business or a poor relation to other business operations. Just as sales/marketing, production, purchasing, human resources, public relations and so on play a vital part in the success of an enterprise, likewise the role of financial reporting is essential to business planning and development. The accounts department is akin to an unsung hero like a defender or goalkeeper in a football team. Strikers will always get the glory but a successful football team is build on a solid defence (ask Jose Mourinho).

If a company wants to sell more product it would be useful to know which products are most profitable. For any given level of production it would be desirable to know whether relative costs are increasing, falling or staying the same. In other words are there economies of scale to be had? If a company wants to grow it’s operations what level of investment will be required and how can this be financed? If loans are needed can the repayments and interest charges be met? A business needs to constantly assess its current situation in the light of increased competition, changing consumer trends, technical innovations and the state of the global economy. It also needs to look ahead and plan for the future. Financial reporting is the basis upon which companies are able to make informed decisions about business operations and strategies. It is therefore a key ingredient to on going success.

In order to achieve accuracy in accounting it is important to match all of the income of an enterprise with all of its expenses for a given time period. This will typically be one year but for management information purposes the year is subdivided by months; hence the terms ‘year-end accounts’ and ‘month-end accounts’. Accounting techniques are used to facilitate this process which are known as ‘pre-payments’ and ‘accruals’. They ensure that income and expenses are allocated correctly between different accounting time periods.

Pre-payments and accruals are just one example of what are generally referred to as ‘adjustments’ to figures in the trial balance of a company’s accounts. A trial balance is just a list of the balances on all the ledger accounts. Other accounting adjustments are often deployed to ensure that recorded transactions give ‘a realistic view of the state of the business’. Examples of adjustments that might typically be carried out include the depreciation of assets, provisions for bad debts, bad debt write-offs and adjustments in respect of ‘private expenses’ or ‘goods for own use’.                .

When the concept of bookkeeping was first originated by Luca Pacioli, a Cistercian monk back in 1494, there were, of course, no computers. In fact it’s quite staggering to think that even the humble pocket calculator only became widely used in the 1970’s. Computers are obviously part of our every day lives now and the application of computer science seems limitless. However, I think it’s fair to say that computers could have been dreamed up especially for accounts and payroll work since the relationship between them goes ‘hand in glove’.

While the principles of double entry bookkeeping and financial accounting have always been sound the application of them in an everyday business situation is quite another matter. The problem with manual accounts work is that it is tedious, repetitive, time consuming and error prone. Imagine running a payroll where you have to manually calculate every individuals tax and national insurance deductions in order to arrive at their net pay. Visualise the job of completing a quarterly VAT return by manually adding up all of the VAT on sales transactions and then doing the same for purchase transactions. As soon as a business gets beyond a certain size manual accounting becomes impractical and unreliable.

Computerised accounting systems have revolutionized business accounting operations for most companies. The benefits to businesses are enormous in terms of reduced costs, time savings, better resource allocation, improved accuracy and direct access to detailed financial information. A myriad of financial reports can now be produced at the touch of a button using the raw financial data contained in the accounts system. These systems are also becoming ever more versatile and sophisticated. In many companies they are intertwined with business operations. For example, consider sales order processing or purchase order processing. Whenever a stock item moves somewhere an accounting transaction is done in real time.

Hopefully by now you will appreciate that for business, at least, we need to hang on to those receipts after all. Bookkeeping, business accounting, whatever you want to call it, is necessary because companies must keep ‘reasonable’ accounting records by law and they also need to engage in strategic planning. If you ever work as a bookkeeper or an accountant you may even find that some of the discipline that goes with accounts work rubs off on your personal finances. Doing an annual bills budget forecast, for instance, or analysing your electricity and gas usage can be very useful. I realize, however, that I may have some way to go in convincing everyone of this!

Why should anyone bother to run a payroll?

Regardless of whether you are the director of a limited company or the owner of a sole trader business, if you employ people then it is a statutory requirement to operate a PAYE scheme via HMRC. This enables statutory deductions such as tax and NI to be made from an employee’s pay. Most people are familiar with these primary deductions because they apply to the majority of employees but there are some deductions that may be less familiar. It is important that employers are aware of and know how to treat all statutory deductions.

In addition to the most common payroll deductions mentioned above there are many others. One example is ‘deductions from earnings orders’ in respect of council tax arrears, non payment of child support or some other debt. These are usually issued as a result of a court order following an employee’s failure to meet certain legal obligations. An employer may also be required to make deductions in respect of a student loan repayment which will become due when an employee earns over a specified amount. Deductions may need be made in respect of a pension scheme. Since 2012 it has become compulsory for most employees to be automatically enrolled in a pension scheme by their employer. Some employees may also wish to make additional voluntary (pension) contributions known as AVCs.

The deductions referred to above are known as statutory deductions. They are examples of deductions that employers are legally obliged to make from an employees earnings when certain criteria applies. This is not an exhaustive list and there are many non-statutory deductions that employers may also need to make. These include company loan repayments, company share purchases, saving schemes, charitable donations etc. A deduction can be made from either gross or net pay depending on whether or not it is taxable. Clearly it is important to get this right.

Back in the mists of time it is probable that an employer would have only been concerned with making deductions from their employees’ pay. However, for many years now it has been a requirement for employers to make statutory payments to their employees in particular circumstances. If a female employee satisfies the relevant qualifying rules relating to maternity leave she will be entitled to receive ‘statutory maternity pay’ or SMP.

These days we are becoming increasingly used to the idea of men taking time off work to participate in the arrival of a new baby. In this case an employee may be entitled to receive ‘statutory paternity pay’ or SPP. Some people may wish to take statutory adoption leave in which case they may be entitled to ‘statutory adoption pay’ or SAP. Another statutory payment that employers will routinely make to their employees is ‘statutory sick pay’ or SSP. It should be understood that all of these statutory payments have qualifying rules that must be met.

One statutory payment that most employees take for granted is ‘holiday pay’. It is worth remembering, however, that payment for holidays taken has not always been an automatic right. Also, the entitlement has increased over the years, now applies equally to part-time and full-time workers and has become additional to bank holidays rather than inclusive of them. Both sick pay and holiday pay are examples of deductions that can be either statutory or non-statutory. All employers must adhere to the minimum requirements relating to sick pay and holiday pay but some companies will also operate more generous company sick pay schemes and allow employees to take additional paid holiday. These are ways by which a company can attract good staff or reward them for loyalty e.g. long service. Redundancy payments can also fall into the category of statutory or non-statutory payments.

There are numerous non-statutory payments that a business may wish to make to it’s employees in addition to basic pay. Examples include overtime, shift pay, unsociable hours premiums, bonuses and profit related pay. These payments will, of course, be subject to tax and national insurance in the usual way.

As well as observing statutory regulations it is also important to maintain accurate payroll records as part of the overall accounting records of a company. Payroll is essentially bookkeeping but it is a specialized area and is usually kept separate from other accounting functions. This separation allows for the processing of highly confidential information. Unlike other accounting functions payroll has a close relationship with human resources and their systems are often inter-connected. The payroll function will either have a totally separate system from the accounts system or it will have a dedicated module within the accounting system.

As with any accounting records payroll records are essential for management purposes. A company will certainly want to know what proportion of it’s overall costs are taken up by salary/wage costs. This will vary between different sectors because some are more service orientated than others. The salary costs for a firm of chartered accountants as a proportion of overall costs will be much higher than, say, those of a manufacturing company. Alternatively, a company may want to look at it’s payroll costs as a proportion of turnover rather than overall costs. There are many ways that a business can analyse it’s payroll records. It may look at staff costs in different departments, compare office staff to shop floor workers or contrast staffing costs across different branches.

To summarise companies need to pay employees for their services but they must also make statutory payments and deductions as required by HMRC plus non-statutory payments and deductions as applicable. The later will depend upon company policy. In additional to performing all the correct payroll calculations, which is usually referred to as the ‘gross to net’, a business will need to analyse payroll data as part of it’s financial reportng. In this way it can make wage/salary comparisons with other companies in similar sectors and maintain control over it’s payroll costs.