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It is important to point out that you should always seek the advice of a professional where your business finances are concerned. It is of great importance that you hire a good accountant to handle the overall management of your business finances. However it doesn't hurt if you understand the terminology and methods your accountant uses.
This section does just that, we have taken the main areas and broken them down, along with examples to help you better understand your business finances.
We are going to discuss the following points:
1. The Balance Sheet.
Basically the balance sheet shows how your finances are arranged, it shows:
What assets you own (buildings, vehicles stock etc)
What debts you have (creditors lend you money/stock and are known as liabilities)
What people owe you (debtors)
What capital you have invested in the business (money paid into the business by you).
The balance sheet is only truly accurate at the time it is made, as your incomings and outgoings are changing all the time. In effect the balance sheet gives you a 'snap shot' of your business finances at a certain date. The way in which the figures are entered onto the balance sheet is known as 'Double Entry', which means that figures taken from one side of the balance sheet are added to the other side to make the figures balance-hence the usage of the term balance sheet!
Follow the link below to see an example of a balance sheet, to give you a clearer understanding of how they work. Balance Sheet.
2. Cash Flow.
The purpose of the cash flow statement is to show the movement and availability of cash throughout your business over a period of time, usually a monthly or yearly format It shows how your cash is made available to pay your suppliers, staff and other 'creditors'. To put it simply the cash flow shows the money you have coming in, the money you have going out and where it goes!
Follow the link below to see an example of a cash flow statement, to give you a clearer understanding of how they work. Cash Flow.
3. Profit & Loss.
The profit and loss account shows how well your business has performed financially in it's trading activities over a set period of time, usually a year. Although profit and loss does not mean cash profit, it is an indication of how well your business turns stock/services into profit and how much of a profit margin it makes.
A profit and loss account should contain the following information:
Sales Revenue (money you have made from trading)
Cost of Sales (stock)
Gross Profit Margin (see ratios)
Operating Expenses (Wages, Bills Etc)
A Profit Before Tax Figure (PBT).
Follow the link below to see an example of a profit and loss account, to give you a clearer understanding of how they work. Profit & Loss.
4. Useful Ratios.
Ratios are used in conjunction with your balance sheets, cash flow statement and profit and loss account. They are used to give you figures on certain aspects of how your business is performing financially. The ratios we are going to look at are:
There are lots more ratios we could discuss, but these are the most common, and useful ones you should know.
This ratio works out the percent difference between your turnover and your cost of sales, before expenses and tax are deducted, it is expressed as:
Gross Profit Margin = (Gross Profit divided by Turnover) multiplied by 100 and is expressed as a percentage.
Using our example profit and loss account this ratio would become:
Gross Profit Margin = 290,000/500,000 x 100
= 58%
This ratio works out the percent difference between your turnover and your net profit before tax (after your expenses are deducted from your gross profit), it is expressed as:
Net Profit Margin = (Net Profit before Tax divided by turnover) multiplied by 100 and is expressed as a percentage.
Using our example profit and loss account this ratio would become:
Net Profit Margin = 50,000/500,000 x 100
= 10%
This ratio works out the number of days it takes you to sell your stock, it is especially useful in working out your wet stock turnover and is expressed as:
Stock Turnover = Year End Stocks divided by Total Cost of Goods Sold multiplied by 365 and is expressed as a number of days.
Using our example profit and loss account this ratio becomes:
Stock Turnover = 35,000/210,000 x 365
= 61 Days
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