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.

Bad Bookkeeping Habits And Their Impact On Your Business

Habitual neglect of bookkeeping duties eventually affect the overall performance and condition of your business. One neglect can form into a habit, which triggers red flag.

1. Not Setting Due Dates and Deadlines

Every business needs to get detailed information about monthly reports. If your bookkeeping is late and inaccurate, the negative result will no longer come as a surprise because you failed to set due dates and deadlines. You need to know when reports will be delivered. You do not want to take a wild guess which direction your business is going don’t you? Plus, ATO can chase you for all your late payments.

2. Not Organising Receipts

A piece of paper can turn into one of your worst nightmares when the ATO comes knocking on your door. It is highly recommended that you organise and keep receipts for up to 5 years. If you have stacks of invoices on your desk, not knowing what to make of them, you need to start including ‘organise’ in your vocabulary.

3. Not Managing Payroll Taxes

The world of payroll management can be complicated that you might find yourself completely alienated by the process. Get someone to manage your payroll taxes to spare yourself form the headache of dealing with it. However, do not go totally hands-off as you still need to check if your bookkeeper is doing things right.

4. Skipping Regular Bookkeeping Training

The only thing constant in this world is change and keeping up with the changes in technology is the only way to stay relevant. Your bookkeeper may still be spending hours burying their heads in stacks of papers when there are easier and faster techniques to run a report. It could have been done better, had you thought about giving your bookkeeper a regular training on the latest bookkeeping regulations and cloud software.

5. Not Integrating Data

What better way to manage data than utilising cloud technology? Business owners are plagued by financial reports because the process that running them entails can be quite tiring. This is where data synchronisation becomes necessary because it reduces error and even improve your time management. What’s not to love?

6. Not Standardising Monthly Financial Reports

The reason for standardising your financial report processes every month is to ensure that you run the same report  on a monthly basis. Standardised reports ensure you track your financial data effectively.

7. Not Keeping Track of the Invoices You Sent

Your business may generate profit, but without a steady flow of cash, the money in your business is still not enough to shoulder monthly expenses. You should know when you will get paid because monthly expenses do not have a ‘pause’ button. You will continue to pay for them regardless of your financial condition.

Know The Difference Between Profit And Cash Flow

When going through a financial report, business owners take a look at cash flow and profit. As a bookkeeper, it is important to distinguish profit from cash flow.  Just because a business is making profit does not mean that cash flow is higher than the bottom-line profit.  Another surprising fact about cash flow and profit is that you can have a negative cash flow when earning a profit and a positive cash flow when you have a loss.

Cash flow refers to the difference between the actual cash used and the actual cash received. This means that the company receives and pays a certain amount of cash. Cash flow is a good guide for determining how your business is doing.

On the other hand, profit is revenue from sales of products and services. They can either be payment in the form of cash. The cash may or may have not been received yet and minus all expenses such as the expenses paid in cash, the expenses to be paid in cash at a much later date and the expenses and the expenses accounted for using other means.
It is necessary to find out whether your company is earning income by taking a look at the profit you are making.  Another way to know if your company is earning income is by tracking transactions including profits, sales and expenses.

Operating cash flow versus non-operating cash flow

Operating cash flow refers to the result of any cash activity taking place in a business operation regardless of whether the cash transaction generates earned revenue or incurs expenses when the transaction was made. A good example is when customers make advanced payments for their future purchases. With advanced payments, the company’s cash holding will have no effect on its current profitability. Another example is when a company choose to prepay future obligations. Prepaying future expenses reduce the company’s cash holdings without necessarily lowering the reported profitability when the cash transaction was made.

Not all cash flows come from the company’s operating activities as they can also be from financing and investing activities. When companies obtain funds or sell and investment from financing, an increase in cash positions will be reported. However, the financing proceeds and investment sale are not considered revenues. Using cash for repayments and investments are not considered expenses, thus they have no effect on the company’s profitability.

Business owners must assess short-term and long-term objectives to identify whether to focus on profits or cash. A company that has a strong current cash position should concentrate on driving more sales. If the company needs additional cash for covering short-term expenses, the profits need to take a backseat.

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.