Knowing your numbers is vital as it allows you to interpret your reports and know if you’re on track to achieve the goals set in your Business Plan.
Here are my top six reasons why you need to know your numbers:
They tell the story of your business, allowing you to interpret the results of your business activity.
This helps you identify the symptoms vs the root causes.
For example, a decline in gross profit is a symptom of many root causes such as ineffective pricing, re-work, poor purchasing, wastage.
Knowing your numbers will enable you to spot an early warning sign of a potential issue.
For example, monitoring how long it takes customers to pay you allows you to quickly respond if that number starts to increase.
Areas of strength and weakness will be highlighted.
For example, your Balance Sheet indicates whether your business value is going up or down.
Understanding your numbers also means you have reliable financial information to base your decisions on.
And finally, knowledge is power.
The more you know about your business, the better your business will be.
We’ll be reviewing each of these key reports to help you understand what you can learn from them.
We’ll work through an example to show key learnings and things to look out for in your reports.
We’ll use the same fictitious company, “Foods Co.”, for the examples.
Your Trading Account tracks your sales, variable costs and gross profit to calculate the return you’re achieving before deducting your fixed overhead costs.
Your gross profit percentage indicates whether your margins are improving or deteriorating.
You can track your results across different divisions or product lines by using multiple trading accounts.
For example, if you have regional locations, having a Trading Account for each location allows you to track how each is performing.
Small adjustments to the items in your Trading Account can have a huge impact on your overall results, which I’ll demonstrate now.
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This is an example of a food manufacturing company’s Trading Account.
As you can see, they had
Click sales of just over $1m and
Click cost of sales of $318,000,
Click giving them a gross surplus from trading of just under $700,000.
Click Their direct costs were just over $450,000,
Click so their gross surplus was $248,749, giving a
Click Gross Profit percentage of 24%.
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Let’s say this company undertakes coaching with their accountant and implements strategies to increase their customer retention rate, resulting in a 10% increase in sales.
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They also work with their accountant to review their inventory processes and reduce their cost of sales by 5%.
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They re-negotiate their contract with their delivery provider, resulting in a 5% saving in their direct costs.
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As a result of these changes,
Click their gross surplus has increased by $140,251 and their
Click gross profit percentage has increased from 24% to 35%.
Understanding your Trading Account allows you to identify areas where small improvements can have a big impact on the profitability of your business.
Your Profit & Loss, also known as an Income Statement, shows all your earnings and costs over the year, and tracks the overall performance of your business.
It matches your income and expenses for the period, with adjustments made for timing differences, for example, sales that have been made but money hasn’t been received for yet.
It’s important to remember that profit is NOT the same as cash.
The profit shown in your Profit & Loss Statement includes non-cash expenses, such as depreciation.
You must ensure you have sufficient profit to cover cash costs, such as loan principal repayments, asset purchases, and drawings.
Your Profit & Loss Statement provides a framework to benchmark your results by using percentages or comparisons between years to compare your business performance to similar businesses.
Businesses are generally valued using a multiplier of earnings, so your Profit & Loss Statement is a fundamental driver of the value of your business.
The higher your earnings, the higher your value.
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This is an example of a Profit & Loss Statement, using the same fictitious food manufacturing company.
We’ve taken the Gross Surplus from the Trading Account and listed all of the expenses, followed by the owners’ remuneration, to calculate the net surplus or loss.
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As you can see, the company is currently trading at a loss of over $113,000.
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Let’s say the company undertakes a review of all their expenses with their accountant and identifies potential savings to be made to their insurances and rent.
They contact an insurance broker and their landlord and negotiate a 5% reduction for both expenses.
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They’ve saved $597 in insurance expenses and just under $3,000 in rent expenses.
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However, you’ll notice that accountancy fees have gone up.
Remember in the previous example, the company had engaged their accountant for coaching and other services.
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Despite the increase in their accountancy fees, the overall net surplus has increased by $138,000 to $24,000 due to the savings made.
Your Balance Sheet, also known as a Statement of Financial Position, provides a snapshot of your business’s financial position at a specific point in time.
It measures the net worth of your business, which is your assets less your liabilities.
It also shows if your business is solvent; if your liabilities are greater than your assets then the business is insolvent and urgent action is needed to fix this.
You can compare different periods to determine whether the business’s net worth is increasing or decreasing between years and can track the strength of the business.
The stronger your Balance Sheet, the easier it will be for your business to survive a downturn.
It also provides a basis to calculate key ratios, such as debtor days and inventory days.
As you can see, the company is currently insolvent as it has more liabilities than assets.
Its working capital is also negative as its Click current assets of $138,475 are less than Click current liabilities of $162,269.
This means the company cannot pay its short term debts from the limited cash, debtors and stock it has on hand.
Urgent action is required to remedy this.
The business needs an injection of funds of Click at least $305,000, which may be in the form of share capital or a shareholder loan.
Assuming the company can resolve these urgent solvency issues, there are other areas for improvement too.
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Over the long term, the company could implement strategies to reduce their debtor days and inventory days to increase their cashflow.
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To calculate your debtor days, divide Debtors by Sales then multiply by 365.
This tells you how long it takes customers to pay.
Currently, this company’s debtor days are 26.
This means that, on average, it takes customers 26 days to pay their bills.
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If they updated their Terms of Trade and requested payment within 7 days and managed to reduce this by 5 days to 21 days, they’d have an additional $13,944 available.
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To calculate inventory days, divide inventories by cost of sales then multiply by 365.
This tells you how long the business holds its inventory before selling it.
In other words, it shows how long your cash is tied up in inventory.
This company currently holds inventory for 74 days.
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If they reviewed and updated their inventory processes and reduced the amount of inventory they have on hand, they might be able to improve their inventory days by 9 days.
This would result in a cashflow boost of $7,860.
So, while this cashflow gain of nearly $22,000 doesn’t fix the solvency issue, it demonstrates how much cash could be saved with some help from their accountant.
The Statement of Changes in Equity shows what happens to the profits.
They could be paid out as dividends or kept in the business as retained earnings.
It represents the net worth, or value, of the company and is a key indicator of the company’s financial health.
It shows whether a company is solvent.
Remember, if the company has more liabilities than assets, it’s insolvent, and funds will need to be paid into the company.
The company has accumulated losses for at least the last three years.
This means the company has no retained earnings and is currently insolvent.
There’s no money to pay out as dividends and no money to re-invest into the company to purchase new assets.
The directors must take action now to increase the profitability of the company.
The Shareholder Current Account records all funds introduced to the business by shareholders or taken out of the business as drawings.
It can help you monitor your personal expenditure from the business, and for businesses with more than one shareholder, it maintains a balance of the amount each shareholder has introduced or withdrawn from the business.
It shows how much the business owes to each shareholder.
If the account is overdrawn, it means the shareholder has taken out more than they’ve put in and now owes the company money.
To put the account back into a positive balance, the shareholder can repay the loan, or the company can increase it’s profit to pay a shareholder salary, or a dividend can be declared.
If your Shareholder Current Account is overdrawn, it’s important to get advice from your accountant as soon as possible to discuss the best options for you and your business.
The Shareholder Current Account shows that, at the start of the period, the company owed its sole shareholder, Mr Doe *click* over $29,000.
*Click* He has introduced $2,000 into the company during the year, but has *click* taken over $9,000 out of the company in drawings and life insurance payments.
*Click* This means at the end of the period, the company now owes Mr Doe just under $22,000.
The amount owed by the company to Mr Doe can only be repaid if the company is solvent and has the cash available to make the repayment.
Because our example company is insolvent, Mr Doe will need to introduce more funds into the company so it’s not trading while insolvent.
To ensure the company will be able to repay the funds introduced, a profit improvement strategy should be implemented so the company becomes profitable.
For example, we demonstrated in the Trading Account and Profit and Loss Statement examples how small changes to processes could result in an improvement of $138,000.
It’s not sustainable for the shareholders to keep introducing money into the business if it’s not profitable.
The Fixed Asset Register, also known as a Depreciation Schedule, records a business’s fixed assets, such as vehicles and plant and equipment, and facilitates the spread of the cost of assets over their useful life.
It provides a basis for keeping track of a business’s assets and can be a useful guide to determine when assets need to be replaced so they can be budgeted for accordingly.
It’s also useful when selling a business as it records the current value of all fixed assets.
The first column of the Fixed Asset Register lists the names of all the fixed assets, with the second column listing the cost of the asset on the purchase date.
*Click*
The next column shows the opening value of the asset at the start of the financial year.
This is the cost less the closing accumulated depreciation from the previous period.
*Click*
The next two columns show any purchases of new assets or disposals of old assets.
A disposal could simply mean that the asset has reached the end of its useful life for depreciation purposes and no longer holds any accounting value.
*Click*
Then we have the depreciation rate and method of depreciation used.
This company uses the diminishing value method which depreciates each asset by a constant percentage each year.
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The next column shows the depreciation for the period, *click* followed by the closing accumulated depreciation.
This is the amount the asset has been depreciated by since it was purchased.
*Click*
And finally, the closing value column shows the current value of the asset.
This is the value that will be recorded in the Balance Sheet.
So, that sums up six of the key reports you should be producing and reviewing regularly.
Each report tells a different story about your business and aids your decision making in a different way.
If you have any questions about any of the reports, send them through now and we’ll answer them shortly.
In the meantime, we’ll move on to understanding the difference between profit and cash.
It’s common for business owners to get frustrated that their bank account doesn’t seem to reflect their profits.
It’s essential that you understand the difference between profit and cash and why a high profit doesn’t necessarily result in more cash in your bank account.
A profitable business can go out of business because it’s starved of cash.
A business running at a loss can survive because it has access to funds from investors or financiers.
In other words, cashflow is every business’s reality.
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To demonstrate the difference between profit and cash, consider these items:
GST - affects your cash balance, but not your profit.
Loan repayments - affect your cash balance but not your profit.
Interest on loans - affects both your profit and your cash balance.
Asset purchases - only affects your cash balance.
Asset sales - also only affects your cash balance.
Depreciation - only affects your profit.
As you can see, even if your business achieved a healthy profit, there may not be any cash in the bank after paying tax, making loan repayments, and buying new assets.
The Business 101 Cycle is another useful way to demonstrate the difference between profit and cash.
First, the owners need to invest money in the business.
This money can then be used to purchase the assets needed to run the business.
The business may need additional funding to buy all the assets they need, so they may take a loan to finance the purchases.
These assets are then used to generate a profit.
You can increase your profit by growing your sales or margins, but overhead expenses can drain your profit and result in a loss if they’re not managed.
The profit then gets turned into cash.
Drains on your cash include slow collection of debtors, high inventory days, loan repayments, tax repayments and payments to suppliers.
A business can achieve cash gains by collecting their debtors faster, decreasing their inventory days, negotiating longer payment terms with suppliers, and reducing tax.
The owners then take cash out of the business as drawings or personal loan repayments.
The remaining cash can then be re-invested into the business to purchase more assets to generate more income.
The aim is to go through the cycle as quickly as possible to increase your return on investment.
After cashflow, business value is the next most important measure of business success.
Part of knowing your numbers is understanding and measuring the drivers of your business value.
These drivers might be your monthly recurring revenue, revenue growth, revenue per client, sales or profit.
These will be different for every business, but we can work with you to identify the drivers of your business value.
To enhance the value of your business, you must first develop and implement a clear plan and document your organisation structure and roles within your business.
Establishing cloud-based, real-time reporting allows you to make better decisions, and reviewing and documenting your systems and processes ensures your business is running as efficiently as possible.
Reducing the reliance on the owners of the business helps enhance the value as it will be easier for new owners to take over when the business is sold.
And finally, identifying and managing risks means these can be mitigated before they become an issue.
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If your business isn’t profitable and doesn’t have much cash available, you won’t be able to pay yourself to fund your desired lifestyle.
There are a few other things you can do to help protect your assets, which I’ll quickly run through now.
Set up your business as a company to limit your personal liability.
Consider who should be a director of your company and which assets are held personally by directors.
Ensure that you have security over any money you lend to others.
Consider alternative ownership structures for high value assets.
For example, if your business owns the commercial premises you use, consider moving the ownership of the premises to a separate limited liability company.
Review your Terms of Trade and credit policies to ensure you only provide credit to customers who are likely to pay you.
Review your insurances and make sure you have sufficient protection.
For example, do you have business interruption insurance, indemnity insurance, and enough cover to ensure the impact on your business of any adverse events is as minimal as possible?
Ensure you undertake financial planning to manage your personal wealth outside of the business.
And finally, plan for the future.
Do you have an up to date will, Powers of Attorney, and a clear plan for transferring your assets to the next generation?
This isn’t an exhaustive list.
They’re just some of the ways you can protect both your business assets and personal assets.
We can help you identify specific ways you can protect your assets.
How does everything I’ve talked about today come together as best practice?
Every business should use the three essential tools:
An annual Business Plan.
An annual forecast.
Ongoing reporting and accountability.
The reporting ensures the numbers you want to achieve in your plan and forecast are being measured.
The accountability process is some form of coaching.
Using an independent coach to hold you accountable works.
Knowing your numbers is just the beginning as it allows you to improve them, and ultimately, achieve your goals for your business.
So where to from here in these challenging times?
My aim is to help you take what you’ve learnt today and implement some positive change in your business.
Now it’s time for you to decide what you’re going to do.
What problems are you experiencing in your business?
Identify these problems and use them as an opportunity to create a project to fix them.
Doing nothing right now should not be an option.
Update this slide with your service options and pricing.
So, now you know what you should be doing as best practice in your business, here’s how we can help you.
If you don’t currently have a Business Plan, we can help you develop one.
We can also create an updated Cashflow Forecast.
For those who need to be held accountable to complete your actions, we have a range of coaching options, depending on the frequency which suits you.
We can create your Management Reports each month, catching up with you to review them so we can discuss potential areas for improvement.
And finally, we offer a complimentary one hour meeting for both clients and people who aren’t clients.
We know it may be difficult to commit to spending money right now.
All of these services include an assessment as to how you can improve your profitability and cashflow, so there will be a great return on investment from this process over time.
For the short term, we have different payment options available, so please don’t let cost be a barrier.
Get in touch and we can work together to come to an arrangement you can manage.
We know that the benefits you’ll get from these services will be far greater than our fee - most importantly, it’s about helping you as quickly as possible and ensuring we are working with you to build a stronger, more resilient business.
By working with you one on one, we’ll be able to identify the most important actions to take that will make the biggest impact on your results.
Turn on your webcam.
Ask if anyone has any questions.
Suggested ‘dummy’ questions:
What is the difference between the annual accounts and accounts that can be produced throughout the year?
Answer = the annual accounts contain year end adjustments for things like depreciation, tax, splitting interest and principal on loans, pre-payments and other Accountanese jargon.
The main difference is that the annual accounts are historical whereas your regular management accounts give you up to date data.
What is the difference between mark-up and margin?
You’ve spoken about gross margin; is that the same as the mark-up I put on my prices?
Answer = Yes and no.
The mark-up in dollar terms is the same as the margin in that both are the difference between the cost price and the selling price.
But in terms of percentages, mark-up and margin are not the same.
For example, if you buy stock for $75 and sell it for $100, your mark-up is 33% ($100 / $75).
The margin is 25% (the $25 profit divided into the sale price of $100).
When no more questions are forthcoming, click through to the next slide.
We hope we’ve given you plenty of ideas to ponder and some clear next steps for you and your business.