Warren Buffett famously said, “If you can’t read the scoreboard, you don’t know the score. If you don’t know the score, how can you tell the winners from the losers?” And that’s the same in business.
In business the scoreboard is a set of accounts. And if you can’t read a set of accounts, how do you know whether you’re winning or losing? So, what’s in a set of accounts? There are three main bits, a profit and loss account, a balance sheet and a cash flow. And I’m going to go through them one-by-one. Watch our video to learn more.
What is a profit and loss account?
Basically, it shows your sales and expenditure for the period. Usually for a year, it will add up all your sales and all your expenses. Those expenses will be categorised under different headings, whether that’s office expenses, purchasing goods, so you can actually see where the money’s gone. And at the bottom, it will show you whether you’ve made a profit or a loss for the year.
Think of your profit and loss account a bit like a movie, because it is moving. It’s over a period of time. So, for example, from the 1st of January to the 31st December, and it show it as everything up that happened during that time. One thing though, you do need to be aware of with the profit loss account is that some of it can be theory rather than fact. That’s because you get to decide on some of the accounting assumptions that are made on how much of an expense is put into the profit loss account in a given year.
The main example of that would be is if you buy an asset. Let’s say you buy some plant and machinery for £20,000 pounds, you do get to choose in your profit and loss account, how much you put in each year. If you think the plant’s going to only last you one year, you put the £20,000 pounds in. If it’s going to last you five years, you put £4,000 pounds in a year.
So, you just need to be aware, when you’re looking at a profit and loss accounts of some of these assumptions that’ve been made.
And do you have to make a profit as a business? Well, it’s preferable and certainly long term you do need to make a profit and that’s one of the reasons you should be keeping on looking at your profit loss account on a regular basis, not just once a year, but preferably monthly.
What is a balance sheet?
The balance sheet basically states all of your assets and liabilities at a given point of time, usually at your year end, so it shows everything you own and everything you owe.
You’ll own assets, so fixed assets, whether it’s plant and machinery, cars, it’s office equipment. You’ll have debtors, you have people who owe you money, your customers and the likes.
You might have stocks if you’re dealing goods, you’ve bought some stuff you haven’t sold yet and that’s sitting on your premises.
Cash is an asset and then there are people you owe money to, your suppliers. You might have some loans, the bank if you’re overdrawn.
And then you add all those up and basically at the bottom you get to an amount that is your business worth at this day. So, your total assets, less your total liabilities.
Now it’s called a balance sheet because when he gets that figure, that’s actually been funded by something and it’s at the bottom of the balance sheet, you actually get that figure again, that made up of where it came from and that will be the shares in the company and they usually, the profit and losses made over the years that have funded it.
Now, unlike a profit and loss account, which is a movie, a balance sheet is just a photo, it’s a snapshot at a given point in time. And it is mainly fact. Again, there are some accounting assumptions in there, but most of it is fact. You can go and touch it.
So, if it says that you have this amount of cash, there’ll be a bank statement or something to back it up. And that safe proof every figure in the balance sheet.
What is a cash flow?
Well this shows the cash movements over a period of time. So, in your annual cashflow forecast, it will show how much cash and that includes all your bank accounts you had on the first day of the year.
It then shows how much was spent or came in to give you a figure at the end of the year.
It categorises that expenditure between the income expenditure on your trade income expenditure, on buying assets and also on any of your investments or loans.
Again, this is like a movie. It’s a moving picture of the business, but the great thing with the cashflow is its fact. There are no accounting assumptions in there.
The bank balance at the start of the year and the bank balance at the year-end are fact. You can’t play with those.
And for many business owners, the cashflow is the single most important financial statement, because you could be making a profit but have no cash.
You must make loads of sales, but if no one’s paying you for them, you’re going to go bust whether you’re profitable or not.
I know a lot of really clever people who only look at the cashflow and they’ve got great businesses.
So, putting it all together, you should look at all three financial statements. They do all tie into each other. They’re all interlinked. And they’re all important.
As I mentioned with the cashflow, is that you need a positive cashflow for your business to survive, but in the long term it doesn’t need to be profitable as well. It needs to have more assets than liabilities.
You can afford even for them to be bad for a short length of time, but it can’t be long term.
How often should I look at my financial statements?
Well, legally you need to prepare them at least once a year, but as a business owner needs to look at them far more often than that.
Perhaps quarterly, but preferably at least monthly. If you don’t know whether you’re making a profit or a loss or whether you’ve got cash, how do you make decisions?
How’d you prepare those financial statements? Well, there are lots of options, but these days some of the easiest ones are through some of the software that’s out there.
Cloud based software is great. It makes things easier and it’s actually aimed at business owners, not accountants. You do not need to be an accountant to use the software. It’s even dead easy in terms of getting the stuff in there, you can just take photos of invoices these days and that will pull them together.
If you do need help, of course, do speak to an accountant to get them to do it for you, but overall, that will give you that scoreboard. You’ll know whether your business is winning or whether you’re losing. Feel free to contact us on gr****@*********************co.uk or by phone on 0151 380 8081.