Two Essential Financial Statements Every Business Owner Should Understand

If there are two essential financial statements that you would often receive from a bookkeeper, these are going to be the Profit & Loss Report and Balance Sheet. Business owners rely on these statements because they show the financial status of the business. Your bookkeeper interpret the figures and explain the how’s and why’s of the figures, but as a business owner, you remain clueless.

It is important that you know how to interpret these figures because they can help you monitor your business performance and make a sound decision. Your financial planners, bookkeeper and financial advisors will also have an idea of the business approach to use.

Balance Sheet

In a balance sheet, you can find the assets, liabilities and equity. Your assets include the items you own and the liabilities are the payments that your business owes. The difference is called equity or net worth. If you are looking for a comprehensive report that will help you tell the key performance indicators of your business, a Balance Sheet is a good financial statement you can refer to. With the use of a Balance Sheet, you will know the return on equity, financial strength, control of working capital and return on capital.

It may take a while before you completely understand a Balance Sheet because of all the technical terms you can find in it. When tracking liquid items, bookkeepers and business owners refer to Current Assets and Current Liabilities. You should be watchful of these amounts because they can help you make the right decision and manage your cash-flow. With the use of bookkeeping software, preparing a Balance Sheet regularly is easy.

Profit &Loss Report

If you want a summary of your business expenses and income, a Profit & Loss Report can provide you the information you need. It gives you an indication of your business’ performance. The report shows the sales, cost of goods sold, gross profit, expenses, operating profit before tax, tax payable and net profit. With a skill developed over time, you will be able to interpret the figures found in a Profit & Loss Report. The gross profit is one of the key elements of the report and it is expressed as a percentage. The Gross Profit Margin is important because it enables you to track your business’ profitability and compare figures with your competitors.

If there is a decrease in the Gross Profit Margin, it could mean an increase in inventory costs, heavy discounting or turning over profits with low margins. The Net profit Margin is measured as a percentage. A Profit & Loss Report must be prepared every month especially if your business is using bookkeeping software. If you practice regular analysis of your business, you will be able to unlock key business drivers. As a result, you will be able to determine the correct pricing, target shrinkage and even control costs.

It may take time before you can master interpreting these financial statements but once you know the significance of these figures, you can easily determine where your business is going. You can also create an effective business planning that increases the chances for success.

Interpreting Profit And Loss Report

Business owners consider the profit and loss report important because it is one of the reports that can determine which direction the business is going. Numbers reflecting on these reports must be interpreted correctly and accurately as there should be no room for mistakes. The bookkeepers will be the one to make some recommendations based on the reports. When a business is losing or making money, a Profit and Loss Report will be a determining factor.

Unfortunately, not all business owners understand the importance of these reports until their business fails. Since interpreting numbers of the second nature of every bookkeeper, it is no longer surprising that they know how to read the profit and loss report.

However, not all business owners can interpret or read a profit and loss report. Some may assume that everything is going in the right direction, but when the report is interpreted, the business is losing money, which is not a good sign of progress. There are various areas of profit and loss report that need more than just a simple interpretation and seeing the numbers go up is not enough.

Net Profit or Net Loss

When the figure shown in the report is positive, it only means that the business is making a profit. A negative figure means that a business loses money. The net profit or net loss provides information of the total of income, less cost of goods sold or purchases less expenses.

Expenses

The expenses provide the figures for business expenses including the cost of goods sold. The expenses also show the categories based on your industry. It also includes the operating expenses such as power, telephone, rent and many more.

Income

The Income shows the total of invoices or sales, which you have invoiced over a certain period of time. The Income does not yet include the investment income because this only falls under a section referred to as ‘other income’. This category is found on the bottom of the report. The business’ income is also called ‘turnover’.

Gross Profit

The Gross Profit refers to the incomes less purchases and the Cost of Goods Sold. It is important that a business owner understands the markup percentages and this is what the gross profit provides. The markup percentages are expressed as a percentage of income.

Cost of Purchases or Goods Sold

The Cost of and Goods Sold are the total of all the expenses that the business has incurred. The expenses are the ones that have contributed to the income of your business. The purchases refer to the inventory items that the company has sold and purchased. The items for sale such as the freight charges are the Cost of Goods Sold.

It is not only the bookkeeper that should be mindful of the figures on the profit and loss report because business owners must also understand these reports. When business owners know how to interpret these reports, it is easy to determine when and how changes can be made if something is not working with regard to the financial aspect of a business.