Understanding Your Accounts
It is important to have an understanding of your accounts to monitor the financial status and success of your practice. These provide useful management information and can help to provide some guidance on developing the practice. A sample set of accounts is shown in Appendix 1 and should be referred to when reading this chapter.
The most important financial statements are the balance sheet and the profit and loss account. A balance sheet is nothing more than a list of the assets accumulated and liabilities owed by the business. The difference between the two represents the net worth of the business. It provides a picture of the financial health of a business at a given moment, usually at the close of an accounting period. It lists a summary of the assets of the business, normally split between fixed and current assets, a summary of the liabilities of the business, and a summary of the owner’s equity (the money owed to the owner of the business). The profit and loss account is an analysis of the performance of the business over the trading year, detailing what income was received, and what expenses were incurred.
The balance sheet is designed to show how the assets, liabilities and net worth of a business are distributed at any given time. It can be prepared at regular intervals – for example, at each month’s end, but especially at the end of each fiscal (accounting) year. By regularly preparing this summary of what the business owns and owes, the business owner or manager can identify and analyse trends in the financial strength of the business. It permits timely modifications, such as gradually decreasing the amount of money the business owes to creditors and increasing the amount the business owes its owners.
The categories and format of the balance sheet are established by a system known as generally accepted accounting principles (GAAP). The system is applied to all companies, large or small, so anyone reading the balance sheet can readily understand the story it tells.
An asset is anything the business owns that has monetary value. Fixed assets are assets of the business that will retain value over a number of years. These include tangible assets such as freehold property, leasehold property, equipment, fixtures and fittings, improvements made to the property, and motor vehicles. Also included within fixed assets are “intangible” assets such as goodwill (the value of the name and reputation of the business, normally acquired when purchasing an established practice). Within most financial statements there will be a separate schedule prepared in respect of the fixed assets of the business.
A typical fixed asset schedule shows:
The historic cost of each individual asset.
The accumulated depreciation (i.e. deterioration in value in respect of each asset at the commencement of that particular trading period).
Detail in terms of the further depreciation charged in that particular trading year.
It can therefore be seen that the difference between the original cost and the accumulated depreciation is the written-down value of each asset.
Current assets include not only cash, stocks of materials and saleable goods, but also money due from patients, the Dental Practice Board or other businesses (known as accounts receivable or debtors) and prepaid expenses relating to the next financial period.
Liabilities are monies owed by the business. These are often split into current and long-term liabilities. Current liabilities can be money the business owes either for products purchased or services received but not paid for at the time of receipt of these goods (creditors). Liabilities can also be negative bank balances, credit card balances and monies owed on hire purchase agreements due within one year. Long-term liabilities are liabilities that have a maturity date of greater than one year. These typically include bank loans, mortgages, hire purchase agreements and any other liabilities maturing in greater than one year.
The owner’s equity (or net worth or capital) is the money put into a business by its owners for use by the business in acquiring assets, less any money taken out of the business (drawings). At any given time, a business’s assets equal the total contributions by the creditors and owners, as illustrated by the following formula for the balance sheet:
assets = liabilities + net worth.
This formula is a basic premise of accounting. If a business owes more money to creditors than it possesses in value of assets owned, the net worth or owner’s equity of the business will be a negative figure.
Net worth is the assets of the business minus its liabi/>