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Understanding Business Financials: The Important Numbers and What They Mean

Written by Tim O'Brien . December 15, 2020
6 min read

Do you ever find yourself staring at your business’ balance sheet and wondering what it all means? If so, you’re certainly not alone! You went into business because you had a terrific idea and the know-how to make it happen, not because you couldn’t wait to produce balance sheets.

Nonetheless, all business owners must come to terms with their financial statements at some point. As your business grows, those numbers hold the secrets to your successes and failures. And if you learn to read and understand them, you’ll have the tools you need to steer your business where you want it to go.

In this article, we’ll go through the business financial reports that are most important and how you can use them for forecasting, planning, decision-making and more.

What Business Financial Reports are Important?

Perhaps you’re just setting up your business. Or maybe you’ve been in business for a while, but you realise that your current record-keeping process isn’t working for you. In either case, we’re here to help. We’ll go through the most critical financial reports and how they can help you succeed.

Balance Sheet

Also called a Statement of Financial Position, a balance sheet provides a snapshot of your business assets, liabilities and net worth at a specific point in time. 

It’s important to remember that assets are anything of value owned by the business. They might include bank accounts, equipment, stock or trade debtors. Liabilities are debts owed to external creditors (bank overdrafts, business loans, employee entitlements, ATO debts and so forth) but could also include amounts owed back to you as the business owner.

Why is the Balance Sheet Important?

Most businesses produce balance sheets at the end of a quarter or financial year, so they have an accurate snapshot in time. This allows stakeholders to know the overall value of the business. 

Business owners should examine their balance sheet regularly to identify areas of concern and errors. Incorrect classifications on the balance sheet might mean corresponding errors in the profit and loss, leading to incorrect tax and GST calculations. 

Balance sheets also help you to spot trends. For instance, if your balance sheet reveals that your liabilities are becoming more significant than your assets, your business could be headed toward insolvency.

Balance sheets are also critical for borrowing purposes. Financial institutions will look to the strength of your balance sheet when assessing your ability to repay debt. 

Additionally, a better understanding of your balance sheet numbers will foster more in-depth analysis through the use of financial ratios. These indicators may help identify cash-flow issues, delays in debt collection and even pricing problems. 

Profit & Loss

A profit and loss (P&L) statement details a business’ revenue and expenses over a time period (usually a quarter or fiscal year). Also called an income statement, the P&L shows whether a business made or lost money during the reporting period.

A profit and loss statement is also helpful in identifying where a business can reduce costs and improve overall performance. 

Why is a Profit and Loss Statement Important?

By periodically recording your business’ income and expenses, you have a better idea of how the business is performing financially. You may gain insights about whether there is scope to increase your revenue, cut expenses or pursue some combination of the two.

Lenders often review a business’ financial statements before they consider lending money, and a P&L statement is a typical requirement. It shows clearly whether your business is operating in the black.

P&L statements also help you with tax preparation. By preparing regular reports, you’ll already have much of the information you need for lodging your taxes promptly.

Cash Flow Statements 

Cash flow financials provide a full overview of your company’s current cash position. With up-to-date cash flow statements, you’ll always know when expenses are due to be paid and income expected to be received.

Why are Cash Flow Statements Important?

A cash flow statement fills in the gaps left by the other financials mentioned previously. For example, a profit and loss statement says nothing about the loan repayments you make to your lender. You might have respectable profits, but the amount of money you pay your lender each month could be putting you out of business.

Cash flow statements explain where your money is going. Increasing inventory, extending more credit to customers and buying capital equipment can all impact cash flow yet all three of these issues aren’t immediately evident on a profit and loss statement.

Your cash flow statement can also help you focus on creating extra cash. If you pay less for equipment, you are creating cash while spending money. Collecting receivables more quickly also helps to generate cash. Concentrating solely on your profit and loss statement may mean you overlook cash flow problems.

And finally, cash flow statements can provide critical insights into your Key Performance Indicators (KPIs). Developing excess cash is a great KPI and may demonstrate how resilient your business is to market difficulties and internal problems.

Proactive Cash Flow Strategies for Businesses

Budgeting and Forecasting

Many business financials focus on the past: where the income came from and how you spent your cash. But budgeting and forecasting project your business operations into the future. Based on sound historical data, budgeting and forecasting financials provide a proactive way for you to make plans and hold your business accountable.

Why are Budgeting and Forecasting Financials Important?

When you create an annual budget, you’ll have measurement metrics that can be used to analyse performance. When periodically compared to the business’ up-to-date financials, you’ll have real-time insights on which to base decisions.

The budgeting process compels management to look at all of the business’ financial activities and assess the necessity of each expense. Budgeting financials can help you to anticipate cash flows with accuracy and gauge the health of your business by comparing actual results with the budget.

Forecasting uses historical data and management insights to predict future business results. Forecasting financials allow you to reallocate both human and financial resources to where they’re most needed and anticipate dips and rises in your cash flow.

Budgeting & Forecasting for 2021

Record-Keeping Requirements

Most financial reports are helpful to your business internally yet don’t matter much to the outside world. The ATO however uses financial information to ensure that businesses are meeting their reporting obligations.

What do you need to know about record keeping requirements? According to the ATO, you’re required to:

  • Keep most records for a minimum of 5 years
  • Make the records easily accessible and in (or easily convertible to) English
  • Lodge monthly, quarterly and annual reports as required by the ATO

If you’d like assistance with understanding and producing business records for your business, seek out the help of a trusted business adviser. Whether you’re just starting out or seeking assistance with your established business, our team at BLG are here to help. Talk with us to discuss your business needs and set it up with a firm financial footing.

Written by Tim O'Brien . December 15, 2020

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