Why Trading Account Is Important For Your Small Business.
The following shows the reasons why trading account is very important for your small business.
Besides, there are two basic formats for presenting a trading account.
However, the two presentation formats used in preparing trading account is will not be treated in this article. It is a topic for a future posts.
For the purpose of this article, the time line is one year. Although a trading account can be prepared periodically; quarterly, half yearly or annually.
Therefore, this article is looking at trading account as it affects a retail business.
- Returns inwards
- Opening Stocks
- Carriage inwards
- Carriage outwards
- Total stocks
- Closing stocks
- The cost of sales
- Gross profits
- Negative Gross losses
Why trading account is important: Gross Sales
Sales represent the total value of goods your business sold during the year.
Please note that assets sold during the year are should not be included in the sales figure.
It can only be included in sales if buying and selling of fixed assets is part of your normal business.
This also called returns inwards.
The represent the total value of goods returned by customers for whatever reason, including defective and damaged goods.
Consequently, the total value of goods returned by customers during the year, should be deducted from your gross sales.
This leaves you with net sales for the year.
Why trading account is important: Opening stocks
Opening stocks represent the total value of goods unsold at the end of the previous year.
In other words, the closing stocks are the total value of all unsold stocks at close of business on December 31 of the previous year.
Therefore they form the opening stocks at hand on the January 1 of the current year.
Purchases represent the monetary value of all goods or merchandise your business bought for sale during the year.
Also note that the cost of fixed assets you bought during the year must not be included in purchases figure.
Carriage inwards represent the amount you paid to transport goods from suppliers to your shop.
The total of such transport expenses must be added to the purchases figure.
In other words, it has the effect of increasing how much money you send on purchasing goods for sale.
Although, due to the competition, some suppliers often offer to deliver your goods directly to your shop free of charge.
Often times delivering goods to your store will depend on:
- your track records of doing business with them
- volume of trade with your supplier
- the importance the supplier attaches to you.
Why trading account is important: Returns outwards
Returns outwards represent the total monetary value of all the goods you returned to suppliers during the year.
Consequently, the total of returns outwards must be deducted from your purchases figure.
This returns outwards has the effect of reducing how money you spent on purchases of goods for sale.
Total Purchases, therefore, is equals to: openings stocks + carriage inwards – returns outwards.
At the end of the year, you will need to conducted physical stock counts of goods in your shop.
If your business is a large one, you can ask your external auditors to come and witness the stock counts.
Your external auditor will not count stocks. He only comes to witness the counts to confirm the authenticity of the figures.
Away from that, the total monetary value of stocks counted at the end of the year is deducted from total purchases.
Cost of sales
The cost of sales is obtained by using the formula: Net purchases minus closing stocks.
Why trading account is important: 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 trading account is an integral part of annual financial statements which many companies are required by law to prepare for their businesses.
Trading account is prepared to reveal how effective and efficient your trading activities have been during the year.
This figure reveals the profit margin between your sales and cost of sales.
If your gross profit is low, maybe less the profit margin you have set, then it calls for rigorous investigations.
Your investigation can reveal the following:
- Selling prices you set are below the prevailing market prices.
- You did not monitor the ruling market prices, thereby reducing your profit margin. You should notice this if you see an unusual number of customers coming to buy from you.
- You are not buying goods from cheap sources, thereby making it difficult for you to compete
- Pilferage (stealing) of stocks is taking place
- Dishonest employees are stealing cash from sales.
- There have 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
- Similarly high incidence of returns inwards, can be due to purchases of goods customers do not need
- Carelessness on the part of your employees, resulting in high incidence of damages 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
- You are not doing enough marketing
- Stock control or poor inventory management
Why trading account is important: 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. It also means that there is no gross profit from your trading account activities.
The consequence of this undesirable situation is that your business cannot meet all of its operating expenses.
Remember that, all your operating expenses will be added to the loss you sustained from your trading account.
Therefore, when you loss from trading activities is added to your general expenses, you will end up with net operating loss. And that is a red flat. That is not what you want.
You should belong to the group of small business owners who erroneously think that keeping accounting records and preparing period trading account is a waste of time.
In fact, if you are doing business with preparing a trading account 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