The two most important financial reports, which are prepared for a business, are the Profit & Loss Account and the Balance Sheet. Unless you’re an accountant or bookkeeper, these reports are still little understood by most. Very often I hear the comment that the report shows a profit, but they have no money in the bank! How is this possible? To understand this, you need to understand these reports.
The first thing to know about these reports, is that usually, both these reports are based on your sales invoices and your supplier bills. They are NOT based on what money you’ve received or what money you’ve paid out. The only time that would be valid is if you run a cash business, where your customers pay in cash, and you buy goods in cash. In all other instances, and how most businesses operate, there is a delay between sending out invoices and receiving the payment from your customer, and the same with the expenses. So that the amounts as reported on the Profit & Loss may not have been received/paid as yet. Therefore you cannot compare these figures to your cash flow amounts.
The second thing to know about these reports is the definition of them. The Profit & Loss is a statement of the “trading” income (sales) and expenses of the business; i.e. how much have you sold, and what expenses have you incurred to make these sales. Example:
Administrative costs 10,000
The above amounts will leave you with a net profit of £5,000.
The Balance Sheet is a statement showing what your company is worth at a certain point in time. This is calculated by what your debts are (bank, loans, creditors and such like) versus what your assets are. The balance of those is the worth (value) of your company. Example:
Building and Furniture £150,000
Bank & Cash £10,000
Bank Loan £22,500
The above amounts will leave you with a net worth of £50,000. The Balance Sheet will also usually show how this £50,000 is financed, such as shares, previous profits/losses accumulated, and such like. You can look at this basically like this: if you stopped trading right now, and all monies owing were paid and received, and all your property was sold, how much would you be left with?
Debtors: what your customers still owe you.
Creditors: what you still owe to your suppliers.
Assets: items or property owned by a business or person which have money value. These can be physical assets such as buildings, machinery or furniture; or financial assets such as debtors or money in the bank.
There is more to say on this subject, so I will continue in the next newsletter!
Until then, and as always, keep it simple and… Flourish and Prosper 🙂