Financial reports are crucial to understanding the health of your business. They usually take the form of profit and loss report, balance sheet, and in some cases, your cash flow summary. If you are a limited company, you will receive your annual accounts from your accountant with a profit and loss report and balance sheet.
However, waiting for your annual accounts to be prepared usually means it is too late to take action – they often arrive a few months after your financial year end, and you are already well into your new financial year. Staying on top of your finances throughout the year has always been important – but even more so now. Your business survival can hinge on you regularly checking and understanding your financial reports – or asking a professional to prepare and deliver the necessary services.
Where cash is tight, and you have the time, make sure you are using accounting software (such as Xero, Sage and Quickbooks) and ensure your data is up to date and ‘clean’. You can then run the reports and monitor your business performance in real-time.
This summary will explain the five main things to look for when you receive or generate these reports.
You’ll find sales data on on your profit and loss report. Here are three questions you’ll need to answer:
- Have you achieved what you expected?
- Have you achieved the growth that you anticipated?
- How did it compare to last year, or the previous periods?
2. Profit margins
You’ll find insights on your profit margins on your profit and loss report too.
Here are the two key areas:
- Gross profit – Firstly is your gross profit enough to sustain the overheads in the business? Again, compare these to prior years and see what was different, especially if, in previous years, your gross profit margin (GP) was higher. Secondly, if your gross profit looks low, are you charging enough for your services/products, or are the costs of delivering those services/products too high?
- Net profit – Did you make a profit or a loss? If you made a loss – do you know what caused this loss? Was it low sales, low GP, high overheads, incorrect pricing? If you made a profit, is it enough to cover the liabilities in the business? (Corporation Tax, loan repayments etc)
3. Net assets
You’ll find your net assets on your balance sheet.
Is this a positive number? A positive number indicates the business has enough assets to cover the liabilities. If this is negative – why?
It may be that you have recently taken on a loan or extended your overdraft. If you have a forecast in place and know how this will be spent, you don’t need to worry, but if you don’t, you might want to consider making a plan (understanding why the additional credit was needed is key to ensure you aren’t just filling a hole in a leaky bucket). At times of uncertainty and crisis, the higher this amount, the more likely the business will be able to weather the storm.
This can be found on your balance sheet.
This is usually called the Current Ratio and is a way to identify how easy your cash situation can be turned around. This is your current assets (bank accounts, accounts receivable) divided by your current liabilities (accounts payable, credit cards, short term finance etc). If this number is less than one, you could be in trouble and you should seek some guidance as to what can be done to improve this. Ideally, you want to aim for a number above two. This would mean you have twice as much liquidity (in assets) than what you owe (in liabilities).
That being said, if the number is too high, it would suggest inefficient management of assets – it helps to compare this number against others in your industry if you can obtain this information.
5. Debt to equity ratio
This can be found on your balance sheet.
This is calculated by dividing your total liabilities by the shareholder equity. What does this look like? The lower the number the better – a high ratio suggests the business is funded mostly by debt. A lower number shows it is funded more by shareholders and is likely to be more sustainable.
Debt is often required, especially in the early years, or in periods of growth and transition, however high debt puts the company at higher risk. It is important to fully understand why your ratio is the amount it is. If you know that you are in a period of rapid expansion, you would expect a higher number, however, it will generate more revenue in the future.
These five key things are essential to understanding how your business is performing. Understanding the numbers enables you to make necessary decisions to improve the business and protect it from a downturn. The more regularly you look at these numbers, the quicker you are able to identify problems. There are other ratios, numbers and percentages that are worth looking at when assessing how your business is performing, but they are often relevant to specific business-types or industries. Your cashflow summary is also key to understanding how much cash you are generating each month – but if you have the figures from your profit and loss and balance sheet reports, you should already have a good idea of where your business is.
If this is the first time you have ever looked at these reports and you are worried about anything, make sure you seek help.
If you have an accountant – send them a quick email asking if you can discuss a few things. Many accountants will include free support and advice in their fees, and they can discuss what additional services may be of use to you and help get a plan in place.
If you do not have an accountant, reach out to one, or ask for a personal recommendation from someone in your circle of business-owning acquaintances. Many will offer a free Discovery Call (initial meeting, prospective client call etc), and you may get some gems from that session, even if you decide not to proceed with them. (I personally always make sure I give one helpful tip to prospective clients when I speak to them on a Discovery Call so that even if they decide not to proceed with us, they are in a better position than before they spoke to me).
We recently held a webinar called ‘Know Your Numbers’ for business owners, helping them make sense of their financial reports which may be of interest and use, but there is also a wealth of information out there on the internet. To help you better manage your business finances, AAT have recently launched a series of short online courses – including the basics of financial statements and how to analyse financial statements.
Do not be afraid to ask for help, do not ignore a problem – it won’t go away. Instead, take action.