Financial statements help you understand the big picture for your business.
Business analytics can help provide the right insights to uncover key performance indicators you can use to make rapid decisions about your business opportunities.
So how would you like to know more about:
- What is the relationship between costs and revenue to make better business decisions?
- Are you confident in understanding the financial snapshot of your balance sheet?
- Do you fully understand the impact of your business activities on your cash flow?
Let us take a look at each of the reports below.
A) Understanding Your Income Statement or Profit and Loss Statement
Your profit and loss statement (P&L) helps you understand your business performance and profitability over time.
It’s sometimes called an Income statement and its main purpose is to list income and expenditure.
Whereas a balance sheet is a snapshot in time, the P&L shows transactions over a specific period of time. This can be a month, quarter, financial year or any other period, and it can be a stand-alone report or a comparative period report.
Together with the balance sheet, these two reports provide a comprehensive understanding of the financial position and performance of a business.
The Profit and Loss Statement has two main sections: Income and Expenses.
These may be further subdivided depending on the complexity of the business and reporting requirements.
Income or Revenue
Income primarily includes main business activities such as sale of goods or services. Other income such as rental income, capital gains or sundry income.
Expenses or Costs
Expenses are usually divided into two sections: Direct costs, or Cost Of Goods Sold, and Expenses.
Cost of goods sold are those that are directly linked to the provision of services or sale of goods. For example, if you buy Iron bars from a Distributor and sell them at a marked-up value, the cost of the Iron bars is a direct cost, not an overhead expense.
Other types of direct costs might be importing and freight costs, contractor costs and conversion costs.
Some direct costs are fixed, that is, they are the same from month to month, or they could be a fixed percentage of sales; others vary in value but are still related to the income producing activities, these are termed variable costs.
Overhead expenses are all the other expenses required to run the business, regardless of the level of income: for example, rent, utilities, bank fees, bookkeeping fees, professional development costs, vehicle costs and staff costs.
Many of these costs form the basis of working out your break-even point, or how much it costs just to open the doors for new business opportunities.
There are some expenses which may be reported as a direct cost in one business but an indirect cost in another type of business, for example, 3rd party merchant fees or contractor costs.
The Bottom Line
Total income minus total expenses results in the net profit (or loss), is often called ‘the bottom line’.
Often business owners are just interested in looking at the bottom line, but a true financial picture requires an understanding of several analytics or reports and an ability to see the big picture that the data is illustrating as well as the trends over time.
In order to get more insights ask yourself these questions:
- What does the P&L tell you about relationships and ratios between sales and expenses, seasonal changes and annual trends?
- Have all the direct costs been allocated correctly?
- Where should I focus my attention so I can Maximize my Profits ?
B) Understanding Your Balance Sheet or Statement of Financial Position
To understand the financial position of a business at a specific point of time, look at the balance sheet.
The balance sheet may also be called the statement of financial position.
Together with the Profit and Loss Statement, and possibly other reports such as the Statement of Cash-flow, these reports provide a complete understanding of the financial position and business performance.
So what’s involved? – The balance sheet has three sections: assets, liabilities and equity.
What are Assets?
Assets are resources that a company owns. They have current and/or future value and can be measured in currency.
Assets may be subdivided on the balance sheet into bank accounts, current assets, (receivable within one year), fixed assets, inventory, non-current (or long term) assets, intangible assets and prepayments.
These include banks and other financial accounts held, accounts receivable (trade debtors), supplier deposits or bonds, stock on hand, property, equipment, vehicles, investments and intellectual property. All of these can be translated into monetary value.
What are Liabilities?
Liabilities are amounts owed to suppliers and other creditors for goods or services already received.
Liabilities may also include amounts received in advance for future services yet to be provided by the business.
Liabilities are generally subdivided into current, (payable within one year), and non-current liabilities.
These include accounts payable (trade creditors), payroll obligations (salaries, taxes, national insurance), customer deposits received, warranties and loans.
What is Equity?
Equity includes owner funds contributed, drawings, retained earnings and shares. The value of the equity equals assets minus liabilities.
Transactions that affect profit and loss accounts also affect balance sheet accounts. For example, providing a service increases the accounts receivable balance, which therefore increases the equity.
The Balance Sheet Equation
The balance sheet must always balance! Asset value = Liabilities + Equity.
For example, if you buy a new vehicle for the business at say $50,000, having paid a $10,000 deposit and taking out a $40,000 loan, the value of fixed assets increases by $50k, but the bank asset value decreases by the $10k deposit paid. The value of liabilities increases by $40k loan, thus leaving the balance sheet balanced on both sides of the equation.
The balance sheet equation shows you how much money you would have left over if you paid all your bills and debts and sold all your assets at a given date. This amount is the Owner’s Equity.
Note that the balance sheet equity total is not necessarily how much the business is worth at market value.
Assets are listed on the balance sheet at their transaction value, which may be very different from the market value.
Some assets may be worth more, and others may depreciate in value.
Business value is calculated not just on the balance sheet figures but many other external factors such as Market sentiments, New Opportunities etc.
C) Understanding Your Cash Flow Statement or Statement of Cash Flows
The statement of cash flows, (also known as the cash flow statement), shows how your business has generated and used cash (and cash equivalents) within a specific time period.
For each of the reporting categories, receipts and payments are listed (money in and money out), and this is reported as a net increase or decrease in cash held for that category.
The net change in all categories is added to the amount of cash on hand at the start of the reporting period to arrive at the current cash on hand figure at the end of the reporting period.
It is another important financial statement to understand in conjunction with the Profit and Loss statement and the Balance sheet.
These three reports provide a good understanding of the financial position of your business.
How Does it Work?
The cash flow statement integrates the information provided by the profit and loss statement and the balance sheet into a current cash position.
The cash flow statement is reported on a cash basis, while your other financial statements are usually reported on an accrual basis.
Accrual income (from the profit and loss statement) is converted to cash by calculating the changes in the balances of asset and liability accounts.
The statement of cash flows is organized into sections that report on different types of business activity.
- Operating activities – all business income, expenses, assets and liabilities (except for those assets and liabilities reported in investing and financing activities).
- Investing activities – the purchase and sale of long-term investments, property, plant and equipment as well as security deposits paid to suppliers or received from customers and dividends received.
- Financing activities – the changes in balances of equity accounts, for example, issuing and repurchase of shares and payment of company dividends if applicable. Loans are also included in financing activities.
Formal financial report packages usually include notes to the financial statements.
The notes contain supplemental information that explain significant items or activities that did not involve cash transactions. The notes may also include detailed reporting of categories that may have been reported as summary totals only in the profit and loss, balance sheet and statement of cash flows.
Other items such as taxes, employee provisions, risk management or related party transactions may also be detailed in the notes.
Why is it Useful?
The statement of cash flows gives you a valuable measure of cash flow in and out of the business over a given period. It shows the ability of the business to pay its bills and fund its operating activities.
This gives you a picture of overall performance.
It also shows the relationships between assets, liabilities, equity and cash accounts. It shows changes and movements over time, whereas the balance sheet and profit and loss reports show account values at a single point in time.
The statement of cash flows gives you vital information on your business.
- How strong is your cash position?
- What is the long-term outlook for your business?
- What activities generate the most cash flow?
- What is the relationship between your net income and your operating activities?
How would you like to uncover the right Business Insights in more depth from your Financial Statements?
If you want to Maximize your Profits and get Cash Flow under control, come and have a chat with CFO Coach today.
We will map out your unique roadmap and help you look for the opportunities to push for a better profit margin on your products.
Get in touch with me to learn more by SMS on +260967924720 or email to Irfan.Sayed@cfocoach.co.zm or Visit www.cfocoach.co.zm
Alternatively you can choose your preferred date to set up a free 15 minute Power Discovery Call at your convenience by clicking the link – CFO Coach.
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