Worrying numbers in your financial statements
Business survival strategy: Understand the numbers behind your business
Your financial statement is your first port of call. It’s imperative that you understand the numbers behind your business, as they will steer your decisions that will protect it. If you don’t hail from a financial background, then working with an accountant is worth strong consideration. Accounting software will also keep your finances clear and organised, but again you need to understand how to interpret the data it presents.
The below list might feel a bit overwhelming, especially if you’re strapped for time already! However it’s worth being aware of these crucial signs in your financial statements that could be indicating your business is starting to fail.
Regularly look at these numbers. The more you look, the quicker you’ll spot any problems that could be brewing. (Again, if you have an accountant in place, they have the experience and knowledge to spot these signs. It’s still important you have an understanding of what you’re looking out for, however, as ultimately the success of your business boils down to you!).
Here are five crucial things to look out for in your financial reports, courtesy of Tamsyn Jefferson-Harvey, Director of Seed Accounting Solutions:
Your profit and loss account will show your sales data. Have you achieved what you expected? Are you growing? How does it compare to last year?
You’ll also find your profit margins on your profit and loss account too. Is your gross profit enough to sustain your overheads? If it looks low, are you charging enough? Or is the cost of delivery simply too high? Your net profit – did you make a profit or a loss? If it was a loss, do you know what caused it? Low sales? High overheads? Incorrect pricing? If you made a profit, is it enough to cover the liabilities in your business?
Your net assets can be found on your balance sheet. If it’s a positive number, it means your business has enough assets to cover the liabilities. If this number is negative, you need to find out why.
Liquidity can also be found on your balance sheet. Usually called the Current Ratio, it’s 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. You ideally want to be aiming for a number above 2 as 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’s worth speaking to an accountant for advice in this scenario.
Debt to equity ratio
Your debt to equity ratio can also be found on your balance sheet. This is calculated by dividing your total liabilities by the shareholder equity. 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.