Every company incurs a variety of expenses in its operations, and often the number of costs it incurs exceeds its income streams. To remain compliant with federal law, collect data to drive company decisions and avoid surprises at tax time, a company uses multiple accounts. Two principal types of accounts are trading accounts and manufacturing accounts.
TL;DR (Too Long; Didn't Read)
A trading account enables a company to determine its profitability. With data from a trading account, the company’s accounting and management teams can decide where it can make changes to cut expenses and increase profits. A manufacturing account is used to determine the cost of manufacturing a company’s product. Data from this account is used in the trading account to calculate the company’s gross profit.
Creating and Using a Trading Account
A trading account enables a company to determine its profitability. With data from a trading account, the company’s accounting and management teams can decide where it can make changes to cut expenses and increase profits.
In a trading account, goods' costs are gathered from sales figures to calculate the company’s gross profit. A company’s gross profit is the percentage by which its income exceeds the costs it incurred to manufacture the product. A trading account makes the following calculation:
Sales - the cost of goods = gross profit
A company might use this formula to determine that for every dollar of income, it makes 50 cents of profit. Thus, a company earning 50 cents for every dollar spent has a 50 percent gross profit margin. Gross profit is different from net profit, which is the percentage by which the company’s income exceeds all of its operational costs, such as the cost to package and advertise its product. Additionally, taxes and interest on the company’s debt are factored into a net profit calculation, which is a lower, yet more precise, figure than the company’s gross profit margin.
The Purpose of a Manufacturing Account
A manufacturing account is used to determine the cost of manufacturing a company’s product. Data from this account is used in the trading account to calculate the company’s gross profit. In a manufacturing account, all the costs associated with manufacturing a product are included to find the real cost the company incurs to produce the product. These costs include:
- employee wages
- materials costs
- energy costs for running machinery and powering the manufacturing plant
- transportation costs for raw materials
- rent or mortgage expenses on the manufacturing plant
The Balance Sheet
After calculating the cost of manufacturing the company’s goods and determining its gross profit or loss, the data from the manufacturing and trading accounts are entered into the balance sheet, a comprehensive statement that shows the company’s operational costs, sales figures, profits and losses. The balance sheet also details the company’s assets and liabilities and enables the company’s leadership to decide on an appropriate, profit-focused direction for the company, often with additional input from a managerial accountant.
Lindsay Kramer has been a full-time writer since 2014. In that time, she's experienced the ups, downs and crazy twists life tends to take when you're launching, building and leading a small business. As a small business owner, her favorite aspect about writing in this field is helping other small business owners and aspiring entrepreneurs become more fluent in the terminology and concepts they face in this role. Previously, she's written on entrepreneurship for 99designs and covered business law topics for law firms.