Keeping an eye on how your business is travelling financially is directly related to your success! Understanding even just the basic elements of your financial reports will give you a sense of control that will help you shape your future business strategy.
These figures and financial reports don’t have to be prepared by your accountant. They are something that you can do right now, even if your financials are run through an Excel spreadsheet. Here’s my top five numbers for you to look for in your financial reports.
Profit
In your Income Statement or Profit and Loss Report, take a look at the very bottom line. Yes, literally the last line! A positive number indicates your business is operating on a profit and a negative number is a loss.
Profit = Sales – Expenses
A profit shows how much you have earned less how much you have spent. Therefore, a positive number means that your business has made enough money to cover all of your costs.
It’s important to note that businesses often make a loss in the first few years of operation and a loss is not always a bad thing. If you make a loss, it’s important that you understand the reason why it happened. Are you giving away free products or services, or discounting to encourage people to trial? Has there been some large one-off outlays during start up?
A loss is fine as long as you can identify the cause and feel confident that you are on the right track to a future profit.
Equity
Moving on to the Balance Sheet or Statement of Financial Position, let’s look at your equity. Equity can be used to indicate financial health of your business as it demonstrates how much you own compared to how much you owe.
You can work out equity by this simple equation:
Equity = Assets – Liabilities
Positive equity means that you own more than you owe.
In a situation of negative equity, it is important to have a solid plan for reducing your liabilities so that you can move your business back into a more liquid state.
Whilst these two numbers are helpful in understanding more about your business, let’s take them to the next level by introducing some comparisons in the form of ratios!
Ratio 1: Profit and Loss per hour = Total Profit / Hours spent working in the business
How much profit are you making for yourself each hour? It’s time to find out!
Hours spent working in the business includes everything. It’s not just hours devoted specifically to your customers, but also marketing, responding to queries, even the time you spend on Instagram!
Different industries will have different ratios, so it is difficult to give a blanket indication of what represents a good ratio or a bad one. But knowing this ratio will enable you to make very specific strategic decisions for your business.
Ratio 2: Profit and loss per $ gross sales = Profit or loss / Gross sales
This ratio will show you your margin. The higher the margin, the more money you make on each sale that can then contribute to your operating costs and debt obligations.
Fast moving consumer goods can survive on small percentages (less than 10%) as the high volume can sustain the business. Luxury or slower moving goods or services need a much higher margin to be able to account for the less frequent sales.
Ratio 3: Liquidity = current assets / current liabilities
This is an indicator of how well your business could survive in the event that you wound up operations tomorrow. It accounts for cash in the bank and other current assets that can be easily converted into cash (such as shares or accounts receivable) that are available to cover liabilities due in the next 90 days (such as overdraft, credit card debt or accounts payable).
A ratio > 1 means that you have the ability to cover your current liabilities. A ratio < 1 is not ideal and needs to be rectified immediately. You would need to increase sales to increase your cash or sell other assets such as a car or equipment to inject the cash into your business.
Your financial reports don’t have to be a source of angst! Work out these five numbers for your business and it will give you the confidence to spot any pressing issues that need to be rectified. It will also enable you to identify the strengths in your business so that you can adjust your strategy to build upon them.
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