An introduction to financial reports

Do you understand the key financial statements available from your business accounts, as well as the information within each of them? If not, read on.

If you don’t have formal accounting training, financial reports can be quite confusing, and may even deter you from looking at them at all, ultimately meaning that you’re ignoring the information they can provide.

Here’s a simple overview of the key financial reports you should be looking at on a regular basis.

Profit and loss

A profit and loss statement (P&L) is one of the key reports for any business to run. It records all your transactions for a given period, usually the financial year ending on June 30. Your P&L tells you how much you’ve recorded as sales for the year, less what you’ve spent – the difference is your profit or loss for the year.

Balance sheet

Your balance sheet records the assets and liabilities of your business at any given date. It’s the equivalent of listing all the things you own (such as your house, car, other belongings and maybe some investments), less all the things you owe (your mortgage, credit card debts, car loan and so on).

In a business you can’t just list these items, you have to keep records of them to satisfy the ATO. More importantly, knowing how to read a balance sheet can give you lots of information to help you run your business, such as a summary of the total amount of money you’re owed and that you owe others.

"Knowing how to read a balance sheet can give you lots of information… such as a summary of the total amount you’re owed and that you owe others."

Accounts receivable and accounts payable reports

The accounts receivable and accounts payable reports are also sometimes referred to as trade debtors and trade creditors reports. While the balance sheet shows the totals due, these reports tell you who owes money and who you owe money to, plus how old the debts are.

Want more articles like this? Check out the financial management section.

Cash flow reports and forecasts

One of the difficulties with the reports above is that they’re prepared on an ‘accrual basis’, in which sales income is recorded when you raise the invoice, not when you get paid; and expenses are recorded when you enter the supplier invoice into your system, not when you pay it. It’s important to prepare your accounts in this way but it does mean that you can’t use those reports to forecast you cash position.

Your cash flow report contains information drawn from a combination of the P&L and the balance sheet, and tells you where the cash in your business has come from, and where it has gone.

This is one of the most misunderstood reports of all. Whereas accountants traditionally prepare a cash flow report covering the past 12 months, most business owners don’t care about cash flow in the past – they want to know what is going to happen to their cash balance in the future. For this, you need a cash flow forecast – we will look at this in more detail in a future article. In fact, the next articles in this series will discuss each of the above reports in more detail.

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Unlock the secrets in your financial reports

Armed with your profit and loss statement, balance sheet and some simple tricks accountants use, you can unlock valuable information about your business.

Learning how to read your P&L and balance sheet are the first steps in getting a handle on your business financials. But to take things to the next level, you also need to be able to analyse the information those financial reports contain.

Read on to discover some easy ways to analyse your data using the same tricks accountants use every day.

You can analyse your P&L and balance sheet much more effectively by using a few ratios, yardsticks and benchmarks. There are many to choose from, but selecting just a few and looking at them regularly can provide great insights, and might just give you an advantage of competitors who fail to do so.

Gross profit margin as a percentage of sales

Each of the products and services you offer will probably yield a different GP. Measuring the average month by month will give you an idea of how your business is performing. Consider an item you buy for $1.00 and sell for $1.50, giving you a mark-up of 50% on the buying price of $1.00, and a gross margin of 50 cents.

The GP margin percentage on that item is expressed as the gross margin divided by the sales price, (50 cents divided by $1.50 or 33.3%). The same is true if you are selling services where you can compare the revenue generated from those services with the cost (usually wages) of providing them.

"If your business is turning over $200,000 a year, 54 debtor days equate to almost $30,000 of your cash that’s still sitting in your customers’ bank accounts. "

When measuring your GP margin percentage each month, consider why it might have varied from what you expected (for example due to the mix of products sold or discounts offered) and consider ways you can improve it in the future.

Debtor days

In Australia, the average debtor days for SMEs currently sits at around 58 days – that is, it takes an average of 54 days from the date you invoice your client until the date you get paid.

If your business is turning over $200,000 a year, 54 debtor days equate to almost $30,000 of your cash that is still sitting in your customers’ bank accounts. Getting paid 30 days after you issue an invoice rather than 54 would add almost $14,000 to your bank balance.

For many small businesses the situation is even worse, with customers taking 60 days, 90 days or even longer to pay their invoices. So if your accounting software doesn’t include tools to help you manage this, it’s well worth considering switching to a system that does – this feature alone could have a dramatic impact on your cash flow.

Working capital

Looking at your working capital tells you if you’re going to have cashflow problems in the near future – which is much more important than looking at your bank account to see how much cash you’ve got now.

To calculate this, run a balance sheet, and compare your current assets (things you own like bank balance and debtors) to your current liabilities (things you owe like supplier invoices, superannuation payments and payments to the ATO). If your current liabilities figure is bigger than your current assets, this is a forewarning of problems to come.

Yardsticks and benchmarks

The easiest way to analyse the results you’re seeing in the measures above is to use your past performance on them as a yardstick by which you measure your current results. As you track your performance over a period of time (e.g. month by month) you’ll be able to see whether the trend is up or down.

If you have a budget for your business, you’ll also be able to see whether your actual results measure up to your expectations.

Finally, it can be very revealing to compare your own results to that of similar businesses, using benchmarking data available from the ATO.

Previous articles in this series have included a brief overview of the financial reports available from your accounting software, how to read your P&L and balance sheet, and how to prepare a cashflow forecast. The next and final article will wrap things up by explaining how to act on all this information to improve the results of your business.

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Use financial reports to improve your biz

If you want your business to thrive, look for ways to continuously improve it. Here’s how the information contained in your own financial data can help you. 

Previous articles in this series have discussed the importance of running and understanding your profit and loss (P&L) and balance sheet reports, and of comparing these to a yardstick (for example a budget or a benchmark).

To get optimal value from this process, you’ll also need to understand what’s working, and keep doing it or improve; and understand what’s not working, and fix it.
Simply repeating what hasn’t worked in the past and hoping for a different outcome isn’t a sensible option.

A simple way to approach this is to use a model called the Deming cycle to help drive ongoing improvement through a series of steps summed up as Plan, Do, Check, Act. (Note that the word “cycle” is key here, because as soon as you finish one round of activity you start the next, with the goal of creating better and better results over time).

Plan

The first step is to formulate a business plan using terms you can use to measure the performance of your business over time. The most common way of doing this is to create a budget for your business that incorporates all your planned operational activities.

“ Simply repeating what hasn’t worked in the past and hoping for a different outcome isn’t a sensible option. ”

For example, if you’re generating lots of leads but taking too long to issue quotes, add a solution to this in your plan (whether that’s a software solution, hiring a person to fulfil this role or whatever), and include that expense in your budget alongside a target to aim for. In the example above that might be to halve the turnaround time it takes for quotes to be issued after a lead is received.

Do

Next, follow through with the decision you made and implement the actions in your plan by hiring the new person, implementing the new software or whatever else you decided on.

Check

Measure your results by running monthly profit and loss reports, and taking the time to analyse the data they contain so you can determine what’s working and what’s not.

For example, if you’ve managed to reduce the time you take to issue quotes from five days to one, how has it affected your sales? (Keep in mind that this is never an exact science, and there’ll be lots of different factors all at play at the same time).

Act

Identify corrective actions that will improve your performance, and incorporate them into your plans for the future.

In other words, if the actions you took to speed up quoting worked, keep doing it (and try to improve it further), but if not, determine why, and consider other things you could try instead, or as well.

Sometimes you’ll discover that your plan worked, but in doing so has created a new problem. For example, your quoting process might now be so efficient that you’ve got more sales than you can comfortably handle!

That requires a new plan – perhaps another new person in an operational role or an enhanced job management process. In either case this takes you back to the beginning of the cycle.

A tiny minority of small businesses thrive and prosper without any planning or business analysis. For the rest of us, the Plan / Do / Check / Act cycle is a simple but invaluable way to continuously improve business performance – especially when used in conjunction with the data in your financial reports.


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