15 Reasons Why You should Prepare A Trading Account For Your Business. A trading account will enable you to know your:
- Sales return
- Opening stocks
- Carriage inward
- Returns outward
- Closing stocks
- Cost of sales
- Gross profits
You need to prepare a trading account for your small business periodically to enable you to track the performance of your business.
The trading account is the best way for you to get first hand info on whether your business is making profits or losses.
This article is focusing on the features and importance of a trading account for a business engaged in buying and selling business merchandise.
In this post, attention is not given to presentation formats; rather emphasis is on the basics.
1. Total Sales
The trading account starts with sales figure. This represents the total value of all the goods you sold during the year.
The sales account must include the value of both cash and credit sales.
However, remember that you should not include any money you receive from sale of fixed assets. This is because such money did not come to you as a result of buying and selling.
The exception to this rule is that you can only include proceeds from sale of fixed assets if and only if buying and selling of fixed assets, such as vehicles, is part of your normal Business.
2. Sales returns (aka returns inward)
This figure represent the total value of all goods returned by customers to your store.
Sales return can occur for a number of reasons, including among others:
- The goods supplied to you are not what you ordered for
- Products are of inferior quality
- Disagreement in prices
- Products are nearing expiry dates
- Goods are experiencing low demand
- products were destroy during shipment
- and so on
If goods are returned to you, you have three options:
- replace the goods concerned
- refund cash to the customer
- or issue him a credit note covering the value of the goods
Note that returns inward has the effect of reducing the total value of your sales during the year.
This is because sales returns are deducted from your sales figure.
3. Opening stocks
The total value of goods that remained unsold in the shop on the last working day of your trading year are called closing stocks.
You can always find this figure from the last trading account of your business.
4. Purchases Account
All the value of merchandise you bought for sale during the year must be recorded in the purchases account.
Your purchases must be added to the opening stocks.
Please not that it does not matter whether you bought the goods on credit or you paid cash for them.
5. Carriage inward
Carriage inward occurs when you pay for the cost of transporting your purchases from your suppliers to your shop.
In some cases, especially if the customer sees you as an important customer, he can deliver the goods to your store without asking you to pay for transport expenses.
However, often times, you will have to bear the cost of transporting the goods you bought to your store.
The money you spend to carry your items from supplier to your shop must be added to your purchases account.
This is because the money you pay to transport your stock items increases the total money you spent on purchases.
6. Returns outward
Similarly, if for any reasons you return goods to your customers, all you need to do is to receive the goods and add them back to your stocks records. The next think you need to do is to ask for:
- replacement of the affected goods
- refund cash to the supplier
- or issue him a debit note for the value of the goods
Returns outward reduces the value of the total purchases for the year.
Often times, it can happen that you take home some goods for your personal use. If you later pay for it, it will be treated as sales.
However, if you do not replace the goods or pay for them, the value will be deducted from your purchases; thus, reducing the purchases figure. See the analysis in the later part of this article for the effect of this on your gross profit.
8. Closing stocks
This is the total value of the goods that have were unsold the end of year.
Closing stocks are the value of all the goods that were unsold at the end of year.
You can do stock counts by self and your team.
However for best and objective result, you can invite an external auditor to come and witness the stock counts.
At the end of the year, closing stocks are deducted from your purchases figure. That takes us to the next item.
9. Cost of sales
When you deduct closing stocks from Sales, what you get is called gross profits.
10. Gross profits
Perhaps, a little clarification will be quite in order here.
It is called gross profits because it is from the gross that you will deduct your entire operating expenses by the time you will prepare your profit and loss account.
11. Importance of Trading account
There are many benefits of preparing a trading account for your small business.
The following are just a few of them:
It will generate stats that you can use to make comparisons and make important decisions about your business.
A trading account can let you know the figures for:
Compare your sales this year with those for the previous years.
You will need to analyze whether, this year, you bought more stocks but made less profit.
Or you less goods but more gross profits.
With further analysis you might be able to find out whether your product Pricing Strategies are appropriate for your kind business.
Furthermore, you might be able to know, for instance, why your customers are returning goods to you after purchase.
You can know from trading account if you buy right or wrong.
For example, you might buying goods nearing expiry dates or goods that are no longer in demand.
Beyond that, you can easily sustain losses if you have to thrown them away or sell them at highly reduced prices because nobody wants to buy them.
You can as well find out if you are buying merchandise from cheap sources.
This is particularly helpful if your purchases are high but your gross profit little.
Or you are simply unable to negotiate favorable terms and conditions with suppliers before you buy.
If you are taking out goods too frequently without replacing or paying for them, this process will reduce your gross profits.
This is because you are depriving the business of the revenue and profits it ought to earn.
15. Closing Stocks
It is possible that some unreliable employees can help themselves with your stocks and you do know not.
In some cases, store keepers can collaborate with suppliers to short supply your order and they later collect the money for the difference from your suppliers. They can use the money for themselves.
16. Gross Profit: sales ratio
This is a great indicator of how your business is doing.
You can get the ratio by dividing the sales figure by Gross profits figure.
For example, if you have marked your products by 35%, by the time you do this calculation and you don’t get a gross profit percentage of 35%, it is time to look more deeply into your internal control systems.
Furthermore, if have not computerized your business processes, then there is no better time than now to go digital.
Most importantly, if your business continues to have constant run of operating losses, you can review:
- It will enable you to make better decisions
- Your entire business processes
- Screen your employees
- Block all potential loopholes for leakages in your business
- Review your business location
- Consider relocating to another place is an option, if need be
- What about changing your products offerings?
- Or Negotiating with manufacturers, importers and large wholesalers?
- Are you doing enough marketing?
- How much are you stretching out yourself?
- What of internal control systems
By Samuel Ijenhi, B.Sc. Accounting, (University of Benin)
Benin City, Nigeria.
Founder: Ijenhi Business Solutions