Every year, you should receive a set of accounts from your accountant that summarise the financial activity of your practice. For many, the figures can be a challenge to understand, so Ian Tongue (left) looks at the key points of your annual accounts and some useful pointers on how to interpret them.
Accounts or financial statements normally comprise of a profit and loss account and a balance sheet and both are prepared up to a financial year/period end. The profit and loss account can also be referred to as an income and expenditure account and both are often interchangeably used, although subtly different. These are a summary of the income and expenses of the practice, which then result in a profit or loss for the business. The balance sheet is a snapshot of the assets and liabilities of the business as at the financial year end date and, for most private practices, can be regarded as the net worth of the business. The way in which your accountant prepares the figures is governed by accounting standards as well as tax legislation and often these can be different – i.e. the accounting treatment differs to the tax treatment. This is the reason why often your taxable profit from your private practice is different to your accounting profit. The financial year-end is normally the end of a month and, for ease, many businesses use the tax or fiscal year-end to prepare their figures up to. There can be cash flow advantages to not having a financial year-end the same as the tax year end and your accountant should explain the pros and cons of adopting this. One very important part of accounting standards and principles is what is known as the accruals basis. In simple terms, this means that you disclose your income on the basis of when you earn money and not when you are paid. When it comes to expenses under the accruals basis, you claim costs on the basis of being incurred rather than paid. For smaller private practices with earnings below the VAT registration limit – currently £85,000 per year – a receipts basis is possible, but generally it works out best to go with the accruals basis from the start to avoid having to transition from one basis to the other later on.
Profits and loss account
When it comes to reviewing the profit and loss account, you should be presented with the current year figures and the previous year, assuming this is not the first period of trade for the business. Comparing the costs year on year and considering whether they are in line with your expectations is a key analytical tool. Many costs will increase as your fee income increases, but others are largely fixed and are not as variable based on fee income. It is common for consultants to pay for expenses outside of their business bank account and it is very important that you make your accountant aware of these costs so that they can be included within the profit and loss account, otherwise you will not get tax relief on these costs and will overpay your taxes.
It is always advisable to prepare a balance sheet as part of your accounts. To do this, your accountant needs to have your bank statements and other source documents. Preparing a balance sheet ensures that you have a reconciled bank account and the fees declared are accurate taking into account a review of the fees raised and income received. It costs more for your accountant to prepare this statement, but it provides you with comfort that when you sign your tax return off as complete and accurate, work has been undertaken behind the scenes to support this statement. It is a false economy to ask your accountant to prepare only the profit and loss account and presenting just these figures is likely to raise your chances of an inquiry by HM Revenue and Customs.
Accounting Profit versus Taxable Profit
A common scenario is for a consultant to look at the accounting profit in their accounts and try and find the same figure on their tax return. It can be the same figure but more commonly the figures are different. This arises due to the tax treatment of an expense being different to the accounting treatment. The most common example is in relation to buying assets to be used in your business such as medical or office equipment. For accounting purposes, you spread the cost of these assets and this is known as your depreciation charge. But for tax purposes, you can actually deduct the cost in year one. In fact, at the moment, there are enhanced allowances whereby you can claim more than the cost to encourage businesses to invest. In this situation, the taxable profit will be lower in the year that you bought assets and potentially higher in subsequent years as you had all of the tax relief up front. In addition to the above, the other most common areas where the accounting and taxation treatment differ are legal fees and entertaining costs. These expenses can be incurred by the business, but tax relief may be restricted or not available.
One of the most important numbers to look at are your debtors, which is a figure shown as a current asset within the balance sheet. The debtors figure represents all monies owed to you at the date that the accounts were drawn up to. Debtors are assets, but the push should always be to collect these debts and turn them into cash within the bank account. Clinical private practices should not really have more than six to eight weeks of income outstanding. So if your private practice has more than that, question why this is the case, as you may have old debts or perhaps part payments against fees and both situations require investigation. Medico-legal work can often take a long time to be paid and, for those starting out, the terms of payment can be rather onerous. When entering into such work, you need to factor the longer payment terms into the rates charged and ensure that when you submit your accounting records to your accountant you include any outstanding debts from earlier years. It is important that you regularly chase your outstanding debts and usually your secretary undertakes this on a regular basis.
Creditors represent expenditure and liabilities that are not paid as at the date the accounts are drawn up. A private practice would not normally have large creditors, but it is important that you look at this figure and understand how much your business owes, which will assist with cash flow and budgeting.
Value-added Tax (VAT)
We are all used to paying VAT on large amounts of our own spending and, outside of private medicine, most businesses have to account for VAT as part of running their business. For clinical private practices, it is unlikely that you would have to register for VAT, as the vast majority of work undertaken is exempt from VAT. The main type of work that is sensitive to VAT is medico-legal or purely cosmetic work. I f your business is VAT registered, it is important to understand how this is accounted for within your accounts, as the income figure is excluding VAT, as are many of the expenses, no doubt. But debtors, for example, would include VAT. It is important that, if you are VAT-registered, you have a greater understanding of the financial figures and your accounting systems are extremely robust. In conclusion, you will receive accounts every year from your accountant and therefore to get the most from them you should take the time to understand the key components and how to interpret them. You should always receive some written commentary on the figures presented, but it is always best to meet with your accountant to discuss the figures, which should improve your understanding of the figures presented.