How to understand your business accounts

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To run a business well, you need to understand your numbers and the story they are telling you.  Jonathan Amponsah CTA FCCA, The Tax Guys advises entrepreneurs to look at a few key numbers from your year-end management accounts

Profit

Are you making a profit and if so what level of profit?

First:  in your profit and loss account (P&L) the bottom figure which will show a profit (positive figure) or a loss (negative figure).

Second: look at the top figure (the sales) and glance through the expenses listed.

Take the bottom figure (let’s assume £15,000 profit) and divide it by the top figure (assume £100,000 sales). This gives you 0.15, meaning for every £1 of income, you’re generating 15p in net profit.

Is a 15% net profit margin delivering the right return for you?

Business value

The balance sheet tells you about your assets and liabilities, your debtors and creditors. When you look at it ask questions like, is this how much I owe my creditors? is this what my customers owe me? If the amount your customers owe you is higher, it’s a red flag. Get the debtors list, review and start making calls.

A positive number means your business has some value. A negative number means you need to improve the situation.

Cashflow

Say your profit figure shows £15,000 but your bank balance is £3,000. Where is the £12,000? Look at your cashflow statement which reconciles your cash to your profit, or ask these questions:

Have your customers paid you late?

Have you drawn more money or dividends out?

Have you paid your suppliers early?

Have you purchased some equipment?

If you answer yes to any of these, it may well be where the £12,000 is sitting.

Margins

When you get your accounts, take the direct costs of sales or direct expenses (called variable costs) out from the revenue. Then divide that number by the revenue. That is your gross profit margin.

Let’s say your revenue is £100,000 and your materials, direct labour or direct expenses cost £70,000. The difference of £30,000 divided by £100,000 revenue is a margin of 30%. This means for every £1 of sales, you are making 30p in gross profit. This is how profitable you are at the gross margin level. It also tells you whether your business model is working.

Here are two red flags. If you’re making £30,000 in gross profit but your fixed costs are £35,000, something needs to change if you’re to remain in business. If your margin is far below the industry average, you need to understand why and take corrective action.

Trends

Trends are important when understanding your accounts. Compare this year’s and this month’s numbers to previous years and months. That way you’ll see if you are on track or if there are anomalies, for example, if your utility bills have gone up by 25%, why is this?

Finally

For good business decisions you, or someone skilled in numbers, needs to interpret them so you understand the story behind them.

Have regular sessions with your accountant, review the key number we’ve discussed here plus other key numbers and drivers of business value, so you keep your business profitable and on track.