Armed with your profit and loss statement, balance sheet and some simple tricks accountants use, you can unlock valuable information about your business.
Learning how to read your P&L and balance sheet are the first steps in getting a handle on your business financials. But to take things to the next level, you also need to be able to analyse the information those financial reports contain.
Read on to discover some easy ways to analyse your data using the same tricks accountants use every day.
You can analyse your P&L and balance sheet much more effectively by using a few ratios, yardsticks and benchmarks. There are many to choose from, but selecting just a few and looking at them regularly can provide great insights, and might just give you an advantage of competitors who fail to do so.
Gross profit margin as a percentage of sales
Each of the products and services you offer will probably yield a different GP. Measuring the average month by month will give you an idea of how your business is performing. Consider an item you buy for $1.00 and sell for $1.50, giving you a mark-up of 50% on the buying price of $1.00, and a gross margin of 50 cents.
The GP margin percentage on that item is expressed as the gross margin divided by the sales price, (50 cents divided by $1.50 or 33.3%). The same is true if you are selling services where you can compare the revenue generated from those services with the cost (usually wages) of providing them.
When measuring your GP margin percentage each month, consider why it might have varied from what you expected (for example due to the mix of products sold or discounts offered) and consider ways you can improve it in the future.
In Australia, the average debtor days for SMEs currently sits at around 58 days – that is, it takes an average of 54 days from the date you invoice your client until the date you get paid.
If your business is turning over $200,000 a year, 54 debtor days equate to almost $30,000 of your cash that is still sitting in your customers’ bank accounts. Getting paid 30 days after you issue an invoice rather than 54 would add almost $14,000 to your bank balance.
For many small businesses the situation is even worse, with customers taking 60 days, 90 days or even longer to pay their invoices. So if your accounting software doesn’t include tools to help you manage this, it’s well worth considering switching to a system that does – this feature alone could have a dramatic impact on your cash flow.
Looking at your working capital tells you if you’re going to have cashflow problems in the near future – which is much more important than looking at your bank account to see how much cash you’ve got now.
To calculate this, run a balance sheet, and compare your current assets (things you own like bank balance and debtors) to your current liabilities (things you owe like supplier invoices, superannuation payments and payments to the ATO). If your current liabilities figure is bigger than your current assets, this is a forewarning of problems to come.
Yardsticks and benchmarks
The easiest way to analyse the results you’re seeing in the measures above is to use your past performance on them as a yardstick by which you measure your current results. As you track your performance over a period of time (e.g. month by month) you’ll be able to see whether the trend is up or down.
If you have a budget for your business, you’ll also be able to see whether your actual results measure up to your expectations.
Finally, it can be very revealing to compare your own results to that of similar businesses, using benchmarking data available from the ATO.
Previous articles in this series have included a brief overview of the financial reports available from your accounting software, how to read your P&L and balance sheet, and how to prepare a cashflow forecast. The next and final article will wrap things up by explaining how to act on all this information to improve the results of your business.
In the meantime, if you have any questions about your financial reports including accounting ratios, yardsticks or benchmarks, please ask them in the comments.