Reviewing your finances

Where forecasts provide an estimate of your financial position, financial statements are historical and outline the actual results achieved. Financial statements are usually produced monthly and at the end of the financial year.

It is important to set aside time each month to analyse your financial statements, to enable you to control and improve your business

Financial statements may include:

  • profit and loss
  • balance sheet

Profit and loss (P&L)

Usually produced monthly, this is a summary of income and expenses for your business. The P&L will inform you whether your business made or lost money for the month under review.

A P&L usually has five main components:

  • revenue (sales/turnover)
  • cost of goods sold (COGS)
  • gross profit (revenue minus COGS)
  • expenses
  • net profit (gross profit minus expenses)
Formula: Sales – COGS = gross profit – expenses = net profit

The net profit will show whether your business has earned or lost money.

When reviewing your P&L it is useful to analyse four key benchmarks or performance indicators (KPIs).

Analysis KPI Formula
What percentage of the sales price covers the cost of providing or producing the product or service? COGS as a percentage of sales/revenue COGS ÷ revenue x 100
Is my business running profitably? Gross profit margin

Net profit margin
Gross profit ÷ revenue x 100
Net profit ÷ revenue x 100
What percentage of the sale price covers the fixed costs of my business? Expenses as a percentage of sales/revenue Expenses ÷ revenue x 100

 

Gross profit is an indicator of efficiency. The higher the gross profit margin the better, as your business keeps more from each dollar of sales. If your gross profit margin decreases over time you will need to determine the reason and take action to address the decline.

The net profit margin is an indicator of how much profit you make (before tax) from every dollar you spend. A fall in net profit margin generally means you are paying more in expenses, which needs to be monitored. More profitable businesses generally spend less of their income on expenses.

View our example profit and loss statement

Your business structure will determine how some expenses are calculated. Your accountant can provide detailed advice regarding your structure.

Sole traders – drawings (money taken by the owner for personal use) are not an expense. Net profit is calculated after the owner’s benefits are subtracted and is the total taxable income of the business. You pay tax on the entire net profit regardless of how much you have taken in drawings.

Partners – if there is a partnership agreement, net profit is allocated according to the proportion set out in the agreement. If there is no agreement, net profit is shared equally between the partners. Each partner pays tax on the amount of net profit they receive, regardless of how much the partner may have taken out as drawings.

Companies – salaries for working directors are treated as an expense along with employees’ wages. Net profit is what is left over after these salaries have been deducted; it is then available for distribution to shareholders as dividends.

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Balance sheet

A balance sheet is a snapshot of what a business owns (assets) and owes (liabilities) at a specific point in time. A balance sheet is usually completed at the end of a month or financial year and is an indicator of the financial health of your business.

A balance sheet is in three sections:

  • assets – including cash, stock, equipment, money owed to business, goodwill
  • liabilities – including loans, credit card debts, tax liabilities, money owed to suppliers
  • owner’s equity – the amount left after liabilities are deducted from assets

Assets and liabilities are divided into current (short-term) and non-current (long-term) as shown below.

Current assets Items of value that are expected to be consumed or converted into cash within the next 12 months, such as stock that turns over regularly and payments from debtors.
Non-current assets Items not expected to be consumed or converted into cash within the next 12 months, such as equipment, vehicles, buildings, and goodwill.
Current liabilities Items expected to be paid within the next 12 months, such as credit card debts, short-term loans, and stock purchases.
Non-current liabilities Items not expected to be settled within the next 12 months, such as mortgages on buildings and long-term loans.

 

View our example balance sheet

Financial health indicators

Your P&L and balance sheet can be analysed in more detail to determine key performance indicators (KPIs) as outlined below.

Analysis KPI Formula
What level of sales do I need to cover all my expenses? Breakeven point COGS +  expenses
Is my business operating profitably? Gross profit margin
Net profit margin
Gross profit ÷ revenue x 100
Net profit ÷ revenue x 100
Does my business have too much debt? Debt to income ratio Total liabilities ÷ sales x 100
Can my business survive an economic downturn? Debt to equity ratio Total liabilities ÷ equity x 100
Can my business afford to pay its bills? Liquidity ratio Current liabilities ÷ current assets x 100
How much working capital should I retain in the business? Working capital ratio Current assets ÷ current liabilities
Is my business earning a worthwhile return? Return on investment Net profit ÷ equity x 100
How quickly is my stock turning over? Inventory turnover Closing stock ÷ COGS x 365
How many days do customers take to pay their bills? Inventory turnover Closing stock ÷ COGS x 365
How quickly am I paying invoices? Accounts payable turnover Accounts payable ÷ COGS x 365
Are my expenses under control? Expenses ratio COGS ÷ revenue

More information

► Attend our workshop: Understanding your business financials
► Seek assistance to understand your accounts from your bookkeeper or accountant
► Speak to one of our advisers or contact a Business Local service provider in your area.

Related Information
Toolkit

Workshops

Take charge of your finances with the help of our step-by-step workshop Understanding Your Business Financials