When watching or following a game of sport do you like to get updated scores during the match or do you wait until the ref blows the whistle and gives you a score?
The financial year can be viewed as one long match and so many business owners do not stop during the match to get a score. They wait for their accountants to give them the score, good, bad or indifferent, after the match has finished and in many cases months and months after the match has finished!
This doesn’t need to be the case as YOU CAN get scores during the year from your financial statements. The problem with this is that so many businesses don’t either know what financial statements they should be using or even if they do know what financial statements they should be using, they don’t understand them or cannot really rely on them as they are not accurate!
This dilemma is one that is faced constantly by small businesses as unlike large businesses they do not have the financial resources to have an accountant produce monthly financial statements for them. Over the years I have encouraged my clients to use accounting software (mainly MYOB) and have educated them on how to produce accurate monthly financial statements that they can use in their business to track their progress. Each of these businesses monitor their “key performance indicators” (KPI’S) and know what the trends are in their businesses. If their trading results deviate from what they consider normal and they can’t get themselves back on track, that is when they contact us for assistance. The key to this strategy is that the clients have made a commitment to accurately record their income and expenses on a monthly basis and they allocate time to review their results on a monthly basis. Renowned management accountant Peter Drucker’s phrase “What gets measured, gets managed” certainly comes into play here and if you start embracing this philosophy, you will be surprised at just how effective this can be for you and your business.
If you are up for the challenge and really want to keep score in your business during the year, here are some basic concepts that will help you Understand your Financial Statements.
Why should you use financial statements in your business?
- to understand the profitability of your business
- to understand trends in your business and plan accordingly
- to understand if you are creating value in your business
- to help you make more informed financial decisions in a timely manner
- to assist you when applying for loans
- so that there are no surprises at the end of the year when we prepare your annual accounts
- to keep score!
What are the main financial statements to use in your business?
- a balance sheet
- a profit & loss statement
What is a balance sheet?
- a snapshot picture of what your business owns and what it owes at a particular date
- ASSETS – LIABILITIES = EQUITY / NET WORTH
- an ideal situation is one where the assets are more than the liabilities
- an ideal trend is one where this number is getting bigger each year
What is a profit & loss statement?
- a moving picture of whether your business has made a profit or loss over a period of time (usually a month, a quarter or a year)
- the main tool to determine how your business is trading
- INCOME – COST OF GOODS SOLD* = GROSS PROFIT (this is what is left to pay for your overheads and to give you profit)
- GROSS PROFIT – OPERATING EXPENSES = NET PROFIT
- NET PROFIT – TAX = RETURN ON YOUR INVESTMENT
- OPENING STOCK + PURCHASES – CLOSING STOCK = COST OF GOODS SOLD
- sales trends can be established (comparing to prior periods or against your budget)
- spending trends can be established (comparing to prior periods or against your budget)
- weaknesses can be identified before they cause too much damage
How can you make sure that your financial statements are accurate & timely?
- make the most of the technology and accounting packages available
- make sure you are using rules so coding is automated
- there should be none or little data entry required & this will give yourself or your staff more time to focus on what the statements are saying
- it takes just as much time to deal with your accounting data correctly than incorrectly – garbage in, garbage out
- have a monthly checklist with the tasks that need to be done to ensure your data is accurate
What your monthly checklist should look like and what tasks should you action each month?
- ensure all data has been entered up to the last day of the month ie. ALL invoices entered, ALL creditors entered if you are using an accruals system, ALL bank, credit card and loan account transactions have been uploaded via the bank feed function and coded correctly, all petty cash payments entered
- record any monthly journal entries ie. depreciation, HP interest, borrowing costs
- reconcile ALL Balance Sheet accounts and have a document supporting the balances
- review the Profit & Loss Statement for any anomalies, incorrect allocations etc
- close off reporting period & lock period in file
How you can make sure your monthly balance sheet is correct?
- reconcile bank accounts, credit cards and loans
- reconcile electronic clearing accounts and petty cash
- reconcile debtors and creditors
- reconcile stock
- reconcile PAYG, SGC & GST
How you can make sure your monthly profit & loss statement is correct?
- review sales (is there anything in these accounts that are not sales – remember this is what you pay tax on!)
- review other income (is there anything in these accounts that are not other income – remember this is what you pay tax on so don’t include in these accounts monies you have lent the business, GST refunds, tax refunds, loan funds!)
- review and confirm all monthly expenses have been entered
- reconcile wages
- reconcile superannuation
How to interpret your balance sheet and profit & loss statement?
Complete your KPI monitoring sheet
- have your accountant assist you with determining what KPI’s are important in your business
- you may also ask your accountant to provide you with ATO benchmark KPI’s for your industry
Review the balance sheet
- have your net assets have increased or decreased?
- do you have sufficient cash reserves?
- are you collecting your debtors quick enough?
- are you able to pay your creditors as and when they fall due or are they getting our of hand?
- review your ATO liabilities by quickly adding up GST payable, PAYG payable and SGC payable – will you be able to pay these as they fall due?
Review the profit & loss statement
- are you happy with your gross profit?
- are you happy with your net profit?
- if you have loaded a budget into your accounting program, how did this months results compare to what you budgeted (this is a great tool and may be something that your account could help you prepare and load into the software for you)
- did you achieve budget for the month?
- what did you do well?
- what didn’t go so well?
- what are your goals for this month?
- do you need to contact your accountant for an appointment?
If this all seems a bit daunting perhaps contact your accountant and invest in a meeting with him/her to help you on your way. Otherwise, take a deep breath and starting working through your balance sheet and profit & loss statement for July 2014, the first month of the 2014/2015 year. Over the years as clients get familiar with the process and are more observant about where transactions are coded during the month, the production of “accurate reports” becomes quite automated and less time consuming, allowing more time to be spent analysing the reports.
The other benefit of this process, is that you will have a greater understanding of your financial reports and the trading results of your business, so when you meet with your accountant, you will have more productive meetings whereby you can really start using their expertise to assist you in growing your business.
Good luck for a prosperous, rewarding and fun 2014/2015!