We’re all in business to make money, right? After all, what’s the point of all your hard work and clever ideas if you don’t make money? Most people who work for a wage know how much they’re making, so why do so many business owners struggle with this knowledge? One reason I would suggest is because it’s not as straight forward as an hourly wage. Sure you have your income, but then after all those cost of sales, overheads and running costs, what are you left with? The process of bookkeeping – and the way many business owners put it off as long as they can – compounds the problem of not really knowing how much you’ve made at the end of the day (or month, or year). Even after your tax return is done and your accountant gives you a bunch of papers with numbers on them, do you really understand what it all means?
The standard set of financial reports are made up of a Balance Sheet and a Profit & Loss Report. When you do your tax return, the tax office looks at your net profit for the year (income less expenses) and the tax you pay is a percentage of that. Your Profit & Loss Report is over a period of time. An annual report is what you use for the tax return, but you could also use the same report for a month or a quarter at a time to gauge how business is going throughout the year. A Balance Sheet is a “snapshot” of what your business is worth on a given day (usually the last day of the financial year, but again, you can prepare a statement for any day of the year). The two reports together will tell you a lot about your business, and if all the effort and work has been worthwhile.
The net profit – what you are taxed on – is only part of the story. You may look at your net profit and wonder, if the report says you made so much, how come you don’t have that much money in the bank? If you are a sole trader, that money has more than likely been used up on your own personal expenses. Profit is also used to pay liabilities (loans and other financial obligations) or to invest in assets (stock on hand, new equipment and the like). As a company or family trust, the profit will be distributed to shareholders or beneficiaries. But if you look closely at your Profit & Loss Report, you can make some interesting observations. Calculate each expense as a percentage of the total sales, and see how some expenses stack up (expense divided by sales times 100). Look at the top 3 – 5 percentages, and these are the expenses that you should keep your eye on the most to keep your costs under control.
The Balance Sheet will list your assets (things you own) less your liabilities (money you owe) to arrive at a net value, which is then balanced by equity (the owner’s investment in the business). You will want the net assets to be as big a number as you can manage. This doesn’t happen by accident, it takes disciplined financial management to spend your money on the right things, and even harder – to NOT spend it on unnecessary things. It does also take time, several years, to build up a strong Balance Sheet. You would want to have good assets, such as: stock on hand, property, plant and equipment, and cash at bank (maintaining a month’s operating costs in cash is priceless if you can achieve it). Your liabilities need to be kept low – pay out debts and loans as soon as you can, meet all your tax and payroll obligations (they do mount up VERY quickly if left unchecked due to cashflow constraints). But what does having a strong Balance Sheet mean?
If you have a reasonable profit, but a relatively low value of net assets, it means that your business doesn’t have much oomph to sustain a blow to the business like a sudden drop in sales, or a substantial machinery breakdown. It also means that you could have spent more on assets to strengthen your Balance Sheet. If you have a low net profit AND a weak balance sheet, then you’re effectively hanging on by a thread. No doubt you will already know this, due to your inevitable hand-to-mouth type cashflow. A low net profit with strong net assets means that you had a tight year, but it’s ok, you’re business has enough to weather through it. Good profit and strong Balance Sheet is where you will know that you’re doing well. You will have to pay tax, but you can take comfort it knowing that when you pay a lot of tax, it means that you made a lot of money. Plan for the future, perhaps it’s time to reward yourself for doing a good job at running your business. Maybe it’s time to take it to the next level and ramp things up?
The smart business owners know exactly how much they are making. They have their accounts up to date – all the time. They show discipline with how they spend their money, and they have a clear vision of what they are working towards, which is always evident in the numbers that come up on the financial reports.
Something that could be hard for some business owners to swallow is that your financial reports reflect exactly the kind of business owner you are. If you don’t like the numbers that keep coming up, remember that you are the one at the helm, and if you want things to improve, no one else will make it happen, it’s up to you.
Understanding what the numbers mean on your financial reports is a critical part of being a smart business owner. Your very future depends on it.
Numbers never lie. Our job as business owners is to understand what the numbers are telling us, and to trust the numbers when we make decisions. In next month’s article, we will look at why just having money in the bank doesn’t mean that all is well.
Until then, keep the numbers working for you.
Evertrue Business Solutions