A simplified guide to reading a UK Financial Statement

Stalking companies on CompaniesHouse and digging into their reports is a great way to understand better the bits and pieces that make the business whole.

Say you have an idea for a business. Most likely, you’ll have some competition. If those companies are in the UK, you can use CompaniesHouse to search for their accounts and figure out how much revenue they had, how many full-time employees and so on. It gives you a brief overview of the DNA of the business without having to hide in the bushes.

But all the fancy terms thrown around in the sheet might not make sense at first unless you are trained in finance. What this post is is my attempt to reduce the number of head scratches one goes through when trying to untangle all of this.

Turnover

When you read this word, think “total sales” or “total revenue” over time.

It helps to answer the question “Is this company actually managing to sell anything to anyone?”

Turnover = total quantity of goods and services x their respective selling prices

If you check the competitor’s website and you see that they sell one product for £100, and their turnover was £1,000,000 you can say that they managed to sell 10,000 units of that product. (This is an oversimplified example. Companies will usually try to sell you more services or make you sign-up for premium packages, so it’s not always as straightforward as that, because turnover bundles all sales under one figure.)

If you look at turnover over the last years, it can give you a good idea of whether the company is growing or declining in sales. If you compare it to other competitors in the space, it can give you a good idea of how much market share they manage to capture.

For example, if you look at a specific industry, take the first 10 companies and analyse their financial statements, turnover can give you a good idea of what sales tactics work best for them. It can help you figure out what companies you should actually focus on breaking down even further, because in the end if they can’t sell anything you shouldn’t try and copy them.


Fixed assets

Tangible fixed assets

These are things that the company owns for long-term use in its operations and are not intended for sale. They are atoms, not pixels.

Examples:

  • Buildings: office buildings, factories, warehouses
  • Plots of land owned by the company for various purposes
  • Machinery and equipment: vehicles, tools, furniture

Tangible assets are subject to something called depreciation. When an asset depreciates, it means that it loses value as time passes and is getting used. (it wears out, becomes less efficient or becomes outdated) Cars are a good example of this.

To calculate how much an asset depreciates you need 3 things: how much the item costs to buy, how long you plan to use it for, and how much you can sell the asset at the end.

The formula is: (Cost of the asset – Price you can sell it for at the end) / How long you plan to use it for

A car that costs 100,000 and is expected to be owned for 5 years and sold at 20,000 at the end depreciates by 16,000 every year.

(100,000-20,000) / 5 = 16,000 per year. For every year that you are using and not selling that asset, you are incurring a cost of 16,000.

You might or might not find depreciation as a separate item in the financial report. It’s usually part of a broader category like “Operating Expenses” and is subtracted from the revenue to give you an idea of how good the company is at getting to operative profit before expenses and taxes.

For example, if your revenue is 100,000 that year, but in order to deliver the service you are using a machine that depreciates at 90,000 per year, it means that you will be way less profitable than a business that can deliver the same service using a machine that depreciates at 10,000 per year.

Intangible assets

These are things you can’t touch but belong to the company and add value.

Examples:

  • Intellectual property: patents, trademarks, copyrights
  • Brand name: the value associated with the company’s brand and reputation
  • Software: 3rd party software acquired by the company

Similar to tangible assets, intangible assets are subject to something called amortization.

A simple explainer of depreciation and amortization

  • They both represent a way to spread costs over time in proportion to value.
  • The main difference between depreciation and amortization is in the type of assets they are applied to tangible assets depreciate, and intangible assets amortize.
  • Even though intangible assets are not physical (so they do not have wear and tear), they are consumed or expire.

The formula for amortization is the same as the one for depreciation.

Amortization Expense = (Cost of Intangible asset – Residual Value) / How long you plan to use it for

Let’s say the company buys a patent for £500,000 and they think they can get value out of it for 20 years. After 20 years, they think they can sell the patent for £50,000.

The amortization expense would be:

Patent Amortization Expense = (£500,000 – £50,000) / 20 = £22,500 per year

Is software an intangible asset?

Depends on the accounting standards and company policies. Internally generated software is generally not recognized as an asset but rather as an expense.

Software acquired from third-party vendors or developed for external sale may be capitalised and subject to amortization.

Calculating the Residual Value of a 3rd party software is tricky because you wouldn’t “resale” the software at the end of your licensing period anymore. Third-party software now uses subscription models rather than a licensing key. In the past, if you would get Photoshop, you would get a licensing key that you could pass forward when you don’t need Photoshop anymore. But now, when your subscription ends, your access to the product ends too – it’s not yours anymore so you can’t resale it.

In that case, the formula would be:

Amortization Expense = Cost of Software / How long you plan to use it for

Photoshop before: £1000 for a license key. You use it for 2 years and can sell it for £200 after. Amortization cost = (£1000 – £200) / 2 = £400/year

Photoshop now: £1000 for a yearly subscription. You use it for 2 years but you don’t own the software, so the Residual Value is zero. You pay £1000 per year and that’s it.


Current assets

Debtors: amounts falling due within one year

This number represents how much money the company needs to collect from their customers in the next 12 months.

Not all clients will pay immediately for their services, but rather have a credit line with the company and pay on a regular cadence.

For example, if your company sells a high-volume service (let’s say credit checks) – your customer might ask to use your service using credit and pay in bulk every 60 days.

That’s money that’s owed to you but not in your bank account yet.

This number provides a good insight into how much liquidity you have in the bank. Having a high number of Debtors but not a lot of immediate liquidity in the bank means that your working capital (money that you can take out now and do stuff with it) can have effects on paying salaries and doing investments.

If you are due to collect £1,000,000 but you only have £10,000 cash in the bank, but your staff expenses are £9,000 every month that is a big no-no. It can suggest you are good at selling, but that your cash flow management needs improvement.

Creditors: amounts falling due within one year

How much money the company owes to suppliers, lenders or other parties and is expected to pay within 12 months.

To correlate that with Debtors, if you need to pay a supplier within the next 12 months £10,000 you would write it under the Creditors: amounts falling due within one year (because you need to pay) and your supplier would write it under Detors: amounts falling due within one year (because they need to collect it)

In the statement you will also find Creditors: amounts falling due after more than one year as a line item, which covers the payments that the company is expected to settle beyond 12 months.

Cash at bank and in hand

This represents how much immediate cash resources you can immediately access and use, without depending on your debitors to pay you or you having to sell any company assets.

Having more cash available on short notice means you can deploy it in short notice for things like operational expenses, paying suppliers, paying people and investing in opportunities.


Net current assets

Also called working capital (or net working capital).

The formula for this is Net Current Assets = Current Assets – Current Liabilities

Current assets

Think of this as “things you own that you can easily convert into cash”

Resources that are expected to be converted into cash within the operating cycle of the company. They are more liquid and readily convertible into cash. (how much money you have in the bank, short-term investments that you can convert into cash, how much money you are owed “Debtors: amounts falling due within one year”,

Current Liabilities

Things you owe that you need to pay within the year.

Some examples: the money you owe to your suppliers (Creditors: amounts falling within one year), short-term loans, salaries earned but not paid yet.

The ratio between assets and liabilities give you a good idea of whether the company has sufficient resources to meet its short-term obligations.


Total assets less current liabilities

Formula: Total Assets – Current Liabilities

Here’s how to differentiate between Total assets and Current assets;

  • Current assets = things you can easily convert into cash into the next year
  • Total assets = the combined value of all resources owned, controlled or held by the company regardless of how fast you can turn them into liquidity

Net assets

It’s the amount that would theoretically remain if the company were to pay off all its debts. Net assets can be seen as a measure of the company’s net worth or shareholders’ equity.

You calculate it by taking Total Assets and substracting Total Liabilities.

When you examine a company’s financial statement, the total assets figure represents the combined value of everything the company owns or controls. This includes cash, property, equipment, inventory, and more. On the other hand, the total liabilities figure represents the company’s debts and obligations.

Here’s a little bit of a recap so far on assets and liabilities.

MetricDefinition
Net AssetsThe value left over when you subtract what a company owes (liabilities) from what it owns (assets). It represents the company’s net worth or shareholders’ equity.
Total AssetsThe total value of everything a company owns or controls, including cash, buildings, equipment, inventory, and more.
Current AssetsThe resources that are expected to be converted into cash or used up within a year, such as cash, inventory, and amounts owed by customers.
Current LiabilitiesThe company’s debts and obligations that are due to be paid within a year, such as bills, loans, and amounts owed to suppliers.
Total LiabilitiesThe total amount of the company’s debts and obligations, including both short-term and long-term liabilities.

Capital and reserves

Called up share capital

This is how much the shareholders collectively have to pay the company for the shares they hold. When a company issues shares, it assigns a specific value to it, known as nominal or face value. Shareholders are obliged to pay this value, or a portion of it to the company. The portion that shareholders are legally required to pay is what is referred to as called up share capital.

If a company issues 1,000 shares at £2 per share, the called up share capital would be £2000. The shareholders collectively have to put up the £2000 depending on how many shares each shareholder holds.

Capital redemption reserve

This is a reserve created by a company to repurchases its own shares.

When a company decides to repurchase its own shares from shareholders, it will put aside some funds to cover the cost of the repurchase.

Retained earnings

How much a company earned and retained after deducing what it paid its shareholders. It represents the portion of net income that is reinvested back into the company.

When a company generates profits or earns income, it can distribute a portion of those earnings to shareholders as dividents or retain them within the company. Retained earnings reflect the accumulated profits that have been retained over time.

Retained earnings are not directly taxed, because that money ends up in the reserve after the profits have been generated and income tax has already been paid.

Here’s an example: company makes £1m in profits. The shareholders own 100% of the company, but decide to issue dividents only for £500,000 and keep the rest for reinvestment. They would pay dividend tax on the £500,000 they take out of the company and keep the rest of £500,000 in a pot for future investments called Retained earnings.


Profit and loss account

This can also be known as income statement, or statement of comprehensive income.

This gives you a general idea of whether the company has generated a profit or made a loss during the fiscal year period. It’s the final result after considering all income and expenses. If it’s positive, the company made a profit. If it’s not, it has a loss.

You can have Net profit or Loss and Profit or Loss

  • Net Profit or Loss = Revenues – Expenses – Taxes – Other Adjustments (interest expenses or income or transactions that are outside the ordinary course of business and are not expected to happen frequently)
  • Profit or Loss = Revenues – Expenses

Shareholders’ funds

The value of the shareholders’ ownership in the company. This does not mean that the shareholders will receive that money in the form of cash – it just signifies how much their stake in the company is worth and their potential claim on the assets and profits of the business.

Wrap up

I hope this helped demystify at least a little bit some of the terminology.

When exploring CompaniesHouse, you’ll quickly discover that financial statements can vary between companies based on factors like size and accounting practices.

Nonetheless, grasping some of the basic terms can guide and prioritize your research efforts for better outcomes.

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Jamie Larson
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