There are 13 reasons why trading account is important for your business.
A trading account will show whether your business made profit or not
You can prepare a Trading Account for your business quarterly, half yearly or yearly, depending on the needs of your business.
Since there are many types of trading accounts, this article is focusing on the Trading Account of a retail business.
Trading account: Gross Sales
Gross Sales represent the total value of goods your business sold during the year.
Please note that assets sold during the year must not be included in the sales account.
You can only include the value of assets sold if buying and selling of assets is part of your normal business.
The represent the total value of goods returned to you by customers during the period.
Customers can return goods to you for a number of reasons including defective or damaged products.
Accordingly, the total value of such goods returned by customers during the year, must be deducted from your gross sales. This is because it reduces the amount of sales you made during the year.
This leaves you with net sales for the year.
Trading account: Opening stocks
Opening stocks represent the total value of goods that remained unsold in your shop at the end of previous year.
It is usually brought forward from the previous year so that they can be sold in the current year.
That is why they are called opening stocks.
Therefore, trading account signals the beginning of another year of trading activities.
Gross purchases represent the total value of all goods your business bought for sale during the year.
All good purchases, whether you paid cash for them or not, must be included in the purchases account.
Also note that the cost of fixed assets you bought during the year must not be included in purchases account.
Carriage inwards represent the total amount you paid to transport goods from suppliers to your shop
Such expenses must be added to the cost of the goods you bought.
It is added because the expenses are directly related to the purchase of goods.
If you never bought, you would have not incurred the cost.
Trading account: Returns outwards
Returns outwards represent the total monetary value of all the goods you returned to suppliers during the year.
You can return goods to the supplier for a number of reasons, including:
- Goods not meeting specification
- Defective products
- Damaged products
Consequently, the total value of goods you returned to the suppliers must be deducted from the sales account.
Thus, returns outwards has the effect of reducing how money you spent on purchases of goods for sale.
Therefore, Net purchases, therefore, is equals to: openings stocks + carriage inwards – returns outwards.
7. Closing stocks
Usually, at the end of the trading year, you will need to do physical stock counts.
You need to do this so that you can prepare the trading account for your business.
If your business is a large one, you can ask your external auditors to come and witness the stock counts.
However, your external auditor will not count stocks. He only comes to witness and authenticate the correctness of the stock counts.
During the stock counts, damaged products that you can no longer sell will be deducted from the stock account. You need to deduct it because nobody will want to buy them.
Moving on, the total monetary value of stocks counted at the end of the year must be deducted from total purchases.
Cost of sales
The cost of goods sold is obtained by using the formula: Net purchases minus closing stocks.
Trading account: Gross profits
Moving forward, gross profit figure is obtained by deducting cost of sales from net sales.
Thus, Net sales – Cost of sales = Gross profits.
The gross profit is a very important metric that can guide in assessing the performance of your business.
The trading account is an important and integral part of annual financial statements companies are required by law to prepare for their businesses.
Trading account will reveal how effective and efficient your marketing effort have been during the year.
This figure reveals the margin between your sales and cost of sales.
If your gross profit is low compared with the profit margin you had set, then you will investigate what went wrong.
Your investigation can reveal the following:
- Selling prices you set might be below the prevailing market prices.
- The low gross profit figure might be an indication that you are not making enough sales
- More marketing is necessary.
- You are not buying goods from cheap sources, thereby making it difficult for you to compete
- Pilferage (stealing) of stocks is taking place in your business
- Dishonest employees are stealing cash from sales.
- There have been expired stocks that you had to throw away because nobody want to put his money in them.
- You are not buying right, hence you might have high incidence of returns outwards
- Returns inwards can mean that you are buying products that customers do not need.
- Carelessness on the part of your employees, resulting in high incidence of damages to stocks during packaging or in transit.
- Profit margin was incorrectly set.
- Lack of comparison of your sales, purchases, gross profits with the figures for the previous year(s)
- No effective internal control systems
- Stock control or poor inventory management
Bonus: If you notice an unusually large number of customers coming to buy from your shop, you should nose around and find out what is happening. Maybe you are selling below the prevailing market price.
Trading account: Negative gross loss
Incidence of gross profit going negative is not common.
Negative gross loss actually means that your business is as good as shut down.
Essentially, it means that:
- You traded at a loss
- Your business cannot cover its operating costs.
The consequence of this undesirable situation is that your business cannot meet all of its operating expenses.
Sadly enough, all your operating expenses will be added to the loss you sustained from your Trading Account, thereby increasing your losses.
Furthermore, negative gross loss from trading account is something that you should not allow to happen to your business.
Most importantly, to enable you ensure that your business is always on track, you need to:
- Keep accurate accounts of your business transactions
- Monitor and keep track of your stocks
- Watch your sales,
- Pay attention to purchases
In fact, if you are doing business without preparing periodic financial statements for your business, you are like a pilot trying to fly an airplane without a compass.
By Samuel Ijenhi
B. Sc. Accounting (University of Benin)
Benin City, Nigeria
Founder: Ijenhi Business Solutions