Understand and Analyse Your Accounts

Understand your accounts

There are two basic financial statements relevant to small business:

Understanding your figures, or financial literacy, is an essential skill for a successful small business owner.

It is important that you understand and can analyse the financial statements of your business so you can manage and control your finances and make more informed decisions armed with facts, not intuition.

You should be able to understand and track the current financial health of your business without solely relying on your accountant. Some basic financial analysis could include making comparisons of your actual financial performance with forecast targets, performance in past years, and industry averages (business benchmarks).

Record keeping obligations

Apart from your legal obligations to keep records, good financial documentation forms the basis of creating financial statements that will paint a true picture of your business. Establishing systems to maintain accurate, up to date financial records will ensure you have the information necessary to make sound business decisions. Read more…

Financial statements provide a summary of all the relevant financial information about a business. Financial analysis can then be performed on these statements to provide management with a more detailed understanding of the figures and the business. Owners and managers use the information provided in the financial statements to make key decisions that affect the ongoing operation of a business.

Analyse your accounts

Once you understand the information provided in your financial statements, the next stage is to analyse your figures in order to gain a better understanding of your business.

Converting financial data to ratios or percentages

Comparing the absolute dollar values over time is not very meaningful and does not provide a complete view of your business. It does not correct for inflation or allow you to make comparisons with other businesses in your industry. We can overcome many of these shortfalls when we convert the financial data to ratios or percentages.

A ratio by itself means little unless it is benchmarked

A ratio needs to be compared to some expected or required outcome. For example, ratios might be compared to different time periods in the same business or to industry expectations to determine whether there has been a significant change.

The benefits of financial analysis

Financial analysis can tell you a lot about the performance of your business and will help you to determine the overall financial health of your business. Issues such as liquidity (does the business have enough cash to pay its debts on time) and profit (the percentage of net profit to total sales) are only part of the financial analysis of your business that puts the information from your financial statements into perspective. Financial analysis will help you identify problems, implement the necessary corrective actions, and improve your operations.

You should develop some "snapshot" measures of your business and set aside time each month to regularly review and analyse your financial statements. In this way you will have better control over your business operations.

You will need information from your annual profit and loss statement to calculate the ratios.

What's next…

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