Small Business Financial Reports: Why are They Useful?
As a small business owner, it is important that you review your financial reports at least twice a year, but preferably more often. Perhaps you are too busy to do this or maybe you don’t understand what you are looking at. While we can’t help create more time in your day, we can help demystify your business’ financial reports so that they make more sense to you and allow you to make better business decisions.
In this article:
- Overview of small business reports
- Benefits of reviewing your business reports
- The business reports you should be looking at
- Profit and loss statement or statement of financial performance
- Balance sheet or statement of financial position
Before we explore the reasons why reviewing your business’ financial reports is recommended, let’s take a look at some of the key reports to consider. A solid starting point for small businesses are the following four reports – we will delve into the specifics of the reports later but for now, here is a brief overview.
Overview of Small Business Reports
1. The Statement of Financial Performance: you might also know this report as the Profit and Loss report or P & L. This report shows how profitable your business has been over a time period. It reports the income your business has generated less your expenses.
2. The Statement of Financial Position: you might also know this report as the Balance Sheet. This report shows the value of your business by reporting the business’ assets (things your business owns), liabilities (things your business owes), and equity (The difference between the two which includes retained earnings and any funds you have introduced to the business).
3. Aged Receivables: this report shows how much money is still owed to your business at a set point in time.
4. Aged Payables: this report shows how much money the business owes at a set point in time.
Benefits of reviewing your business reports
So why take the time to review reports when you are too busy running your business? Here are 6 reasons why we think it is imperative for business owners no matter what the size of your business:
1. To gain a better understanding of your business: by reviewing your profit and loss every month you get a better picture of how your business is performing and you will get a feel for what goes into making your business profitable. By comparing periods you can identify trends and pick up issues or areas of concern earlier.
2. To provide accurate information to lenders or prospective buyers: any lending institution or prospective buyer is going to ask to see your Profit and Loss and balance sheets going back at least 2 years. They will learn a lot about your business by looking at these two reports in conjunction so making sure you are capturing accurate information to provide is key.
3. To reduce bad debts: by looking at your Aged Receivables report each month you can follow up on overdue accounts quickly and generally this results in getting paid quickly. The longer an overdue amount is left unpaid the higher the risk that it will turn into a bad debt so using this report to keep on top of the money coming into your business is important.
4. To keep on the right side of your suppliers: by reviewing your aged payables report each month you will be alerted to any unpaid or overdue accounts. Paying your suppliers on time is important to maintaining good relationships with them so that you can rely on them to provide the services you need when you need them.
5. To better manage your business’ cashflow: having a clear picture of how much money the business owes and how much is owed to the business helps with cash flow planning to make sure that there is enough money available when it is needed. Also, looking at the trends in expenses or revenue coming in can help you plan marketing initiatives to increase sales in the slower months.
6. To make better business decisions: having a better understanding of what is happening in your business will allow you to make more informed and sound business decisions. For example, understanding the business’ fixed or overhead expenses will help you work out your break-even point or how much it costs you just to operate your business.
Now that we’ve considered why reviewing your business reports is important, let’s take a more detailed look at what story each of the reports is telling us.
The business reports you should be looking at
1. Profit and loss or statement of financial performance
The main purpose of a profit and loss statement (P&L) is to capture income and expenditure. The report helps you understand your business’ profitability over time. Whereas a Balance Sheet is a snapshot in time, the P&L captures transactions over a specific time period. This could be a month or a quarter or a financial year. The report can also stand on its own or it can be used to compare prior periods.
The P&L is usually divided into two main sections: income and expenses. These can be further subdivided depending on the complexity of the business and your specific reporting requirements Remember though, to provide detailed reports you need to have detailed and accurate data input.
a. Income (or revenue): income primarily includes your main business activities such as the sale of goods or services. Other income such as interest received or gains from the sale of assets is also reported here.
b. Expenses: expenses are usually divided into two areas – direct costs or cost of goods sold and other indirect or overhead expenses. Direct costs are ones that are directly linked to the provision of services or the sale of goods. For example, if you are a builder and you purchase materials to build with, the cost of the materials is a direct cost. Other examples might be contractor costs or the hire of equipment. These direct costs generally increase or decrease in line with the income-producing activity. Indirect or overhead expenses are all other expenses required to run the business regardless of the level of income. Examples here might be rent, bank fees, bookkeeping fees, etc.
The bottom line of the profit and loss statement is your net profit (or loss) which is your total income less your total expenses. Looking at the bottom line of the P&L is important but it is not a true picture of the business as often you need to review and understand several reports and analyse the trends over time.
Here are some questions you can ask to help analyse the story your P&L is telling:
- What does your P&L tell you about the ratios between sales and expenses?
- Do they change seasonally or over the course of a year?
- Have you allocated all your direct costs?
- Does your bookkeeping capture expenses in a detailed enough way to provide you with the information you need?
- Have you recouped all your billable expenses from your customers?
- What is your break-even point after you cover all your indirect costs?
2. Balance sheet or statement of financial position
Your balance sheet measures the health of your business at key points in time. Here are four measures that the balance sheet tells you about your business.
a. Net worth of your business
Your balance sheet captures all of your assets and liabilities and the net worth or equity of your business is your total assets less total liabilities. Assets include things like money in bank accounts, plant and equipment, and your accounts receivable balance. Liabilities include things like bank loans and credit cards, your accounts payable balance, and any hire purchase balances.
Both assets and liabilities are usually broken down into current assets and liabilities. Current assets are ones that can be converted into cash within 12 months, for example, your accounts receivable balance. Current liabilities are ones that are expected to be paid within 12 months. Non-current assets aren’t expected to be converted into cash in the short term. Non-current liabilities are expected to be paid within 12 months.
Equity is the difference between your assets and liabilities and includes retained earnings (profits or losses from prior years not taken out of the business) and any owner’s funds introduced to the business. If your business was to be wound up, this is the amount you would be leftover with as the owner of the business.
Your balance sheet will tell you if your business is solvent or not! If your business is insolvent, without you taking immediate action to fix this, it’s unlikely your business will survive for long. What are the two indicators of solvency? Let’s take a look at the two key ratios or indicators of solvency:
- Current ratio: the ratio of current assets divided by current liabilities. If this ratio is greater than one, it means that your business is able to cover the money the business owes with the current assets. The higher the number, the greater the cushion in case of unexpected decreases in income.
- Net worth: as we discovered the net worth of your business is the total assets less the total liabilities. If this is a positive number then this is a good indicator of solvency.
c. Strength of the business
By comparing your balance sheet to previous periods you can track whether the net worth of your business is increasing or decreasing. The stronger your balance sheet, the easier it will be for your business to survive a downturn. If your equity is decreasing over time, it is clear that you need to make decisions to ensure that the value of your business remains positive if you want to keep operating.
d. Key ratios
These ratios allow you to compare your results each year and also compare your business to industry benchmarks. They can also highlight areas for improvement. Key ratios using measures from your balance sheet can tell you a range of things about your business.
How we can help
At Bristax, small business accounting is one of our specialist areas. We provide full tax and accounting services Australia-wide via the internet, email, and phone. Our small business accountants would be happy to speak or meet with you to discuss your situation. We’ll take the time to understand your circumstances and provide advice that maximises your financial position.
Contact us now.