In order to make sound financial decisions a business owner needs to have access to accurate, sound and up to date financial information. Some financial reports used include the Profit and Loss account (P&L), Balance Sheet (BS) and Cash Flow Forecast. None can be used in isolation, but instead they must be reviewed collectively as each will tell a part of the financial story.
For a new business owner, the to-do list can seem endless, daunting, and at times overwhelming. The thought of having to learn accounting skills may not seem to be a key priority.
Statistics show that 50% of new businesses fail in the first four years.
To guard against this, a business owner needs to have Policies and Procedures in place, which can help protect against poor decision making. Having sound accounting and financial policies in place can help identify issues before they escalate.
The increase in the rules and regulations governing financial accounts have changed the way businesses are operating and, as a result, many businesses are having to employ a financial controller and/or financial manager.
One very interesting statistic states: ‘The State of Accounts report shows that 37% of small and medium-sized business owners think accountancy is becoming more automated and that they can complete a range of tasks themselves.’
We believe that A2X is a tool that makes it easier for people with limited or no accounting knowledge to start their business and still have access to accurate and timely financial information. This helps make more informed decisions to help grow businesses.
It is crucial to have a basic knowledge of the financial accounts and the story they tell, so that you can understand and interpret your financials in a meaningful way.
Profit and Loss account
The Profit and Loss (P&L) statement summarizes the sales revenue and expenses over a specified period - generally a month, quarter or year. Other names include Income Statement, Statement of Operations, Earnings Statement and Expenses Statement.
Profit and Loss Reports are generally produced under the accrual methodology which means that the P&L and Cash Flow statement should be reviewed together. This is because revenues and expenses can be reported long before the cash exchanges hands.
It is also important to review different periods for example compare year on year figures to ensure that the growth of revenue is higher than the growth of expenses.
Revenue is also referred to as Sales Income.
The sales recorded during the reporting period. The lower your revenue number is, the lower your expenses must be in order to remain profitable.
With A2X you can split your revenue by:
Group all Sales
Group by SKU
Group by Product type
Group by Country
Group by fulfillment channel
Cost of Goods Sold (COGS)
The costs directly attributable to the selling of your goods and services. They can include stock purchases (raw materials; stock for resale), shipping costs, warehousing, distribution expenses etc.
Revenue – COGS = Gross Profit
The money that is available in the business to pay expenses and operating costs.
Selling price of a widget $5
Cost price $1.75
Gross Profit $3.25
Many businesses report the Gross Profit as a percentage:
(Gross Profit / Sale Revenue) *100
A higher percentage is preferable as it indicates more finance available to cover expenses/costs.
Expenses can also be referred to as Overheads. They are the costs of doing business, which are not directly attributable to the sale of goods or services.
Generally, the largest expense in a business are the salaries/wages, however, the online businesses are nowadays changing this statistic.
Gross Profit – Expenses = Net Profit
The amount left over after all costs, both direct and indirect, have been paid by the business. It is also known as Net Income or Net Earnings.
Please Note: Even if your P&L shows a profit, it does not necessarily mean that you have cash available in the bank. This is due to recording business transactions using the accrual methodology.
There is a well-known trap that many business owners fall into –
‘We think in Profits but Spend Cash’
To really know your numbers and to make sound financial decisions, you need to review all three financial reports in unison – P&L, Balance sheet and the Cashflow forecast.
The balance sheet is also referred to as the Statement of Financial Position.
Unlike both the Cash Flow Statement and Profit and Loss Account, it reflects a snapshot in time. In other words, it reflects the financial position of the business at a specific date in time.
The balance sheet is broken down into the following sections:
Assets are items owned by the company, deemed to have future economic value. Prepaid expenses are also included within the asset section. These can include prepaid advertising, prepaid insurance, prepaid rent. This means that the expense is paid in advance of the service/product being received.
The asset classifications and their order of appearance on the balance sheet are:
- Current Assets: Cash at the bank and other resources that can be turned into cash or used up within a year from the balance sheet date. Current Assets are listed in the order of their liquidity (the ability to be turned into cash)
- Long term assets: Investments held by the company including funds held for construction and long-term investments in stocks and bonds.
- Property, Plant and Equipment: Included are land, buildings, leasehold improvements, equipment, furniture, fixtures, delivery trucks, automobiles, etc. that are owned by the company. These are generally referred to as Long term Investments or Fixed Assets.
- Intangible Assets: These include trademarks, goodwill, copyrights, and patents and are reported as cost on the balance sheet.
These are the obligations of the company. They are the amount owed to a creditor for a past transaction. Some examples include bills due to a supplier or interest due on bonds.
The Liabilities of the company can be classified as:
- Current Liabilities: These are obligations due within a year of the balance sheet date. Accounts Payable is an example of a Current Liability. This is the amount you owe having bought items on credit. A business manager should pay particular attention on accounts payables to ensure that they are not slowly creeping up and to ensure that you have the resources to cover them.
- Long term Liabilities: These are obligations due after a year of the balance sheet date. A good example are Bonds payable.
Please Note: Some Liabilities fall under both classifications. For example, a long-term loan with monthly repayments. The 12-months repayment amount should be reported as a current liability and the remaining loan amount outstanding should be reported as a long-term liability.
This is sometimes referred to as the Book Value of the company.
Owners Equity = Assets – Liabilities
This includes Paid In Capital such as Common stock, Preferred stock, and Retained Earnings (money not paid to shareholders as dividends).
The balance sheet tells an investor and the business owner how much the company assets are worth and how the company is financed.
As the balance sheet is a snapshot in time it can not be used in isolation as it can not predict trends playing out. It can be compared with previous periods and with those of similar businesses operating in the same industry.
The balance sheet can be used to derive a number of ratios which will help the investors and the business managers analyse how healthy the company is.
Cash Flow Statement
The cash flow forecast predicts the flow of cash over a future period.
The main reason for producing a cash flow statement is to ensure you can meet your current obligations to suppliers and to identify any shortfalls in cash balances so that action can be taken early.
It doesn't only identify whether your business will have troubles meeting its obligations, but it will also provide an early indication whether its debtors are struggling to meet their obligations.
All three of these statements will be required if you approach a bank or any financial institution for a loan. They will review them critically to evaluate whether the company is in a strong enough position to service the loan.
It is true that some industries are more cash intensive than others. NO business can survive in the long term without generating positive cash flow. Cash Flow is the life blood of ALL businesses and therefore any business owner/manager must have access to, and be able to read a cash flow statement. The Cash Flow Statement acts as the reconciliation link between the Balance Sheet and the Profit and Loss account.
- Cash flow from operating activities: This shows the cash used by, or provided by, the normal operations of the business. This is the core of the business. Total Net Cash is a number you want to see growing.
- Cash flow from investing operations; The section will list all the cash used, or provided, by the purchase, or sale, of income producing assets. These assets may be equipment, property, machinery, vehicles, furnishings, or investment securities.
- Cash flow from financing activities: This section measures the flow of cash between the company and its owners and creditors.