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As a business owner, understanding your financial reports—particularly your Profit & Loss Statement and Balance Sheet—is essential for tracking your business’s performance and planning strategically.
The Profit & Loss Statement (P&L)
The Profit & Loss Statement (also known as an Income Statement) shows your business’s income, expenses, and profit over a specific period. This report provides insights into whether your business is making a profit or incurring losses.
Key Components of a P&L Statement:
Revenue (Sales): This is the total income earned from goods sold or services provided.
Cost of Goods Sold (COGS): Direct costs associated with producing goods or services, like materials or labour.
Gross Profit: Calculated as Revenue minus COGS.
Operating Expenses: These are indirect costs like rent, utilities, salaries, and office expenses.
Operating Profit (EBIT): Gross Profit minus Operating Expenses.
Net Profit: The final profit after all expenses, taxes, and interest have been deducted.
What the P&L Statement Doesn’t Show
While the P&L is great for understanding profitability, there are several important aspects of your business that it doesn’t capture:
Owner’s Drawings: If you, as the owner, take money out of the business for personal use, this is not shown on the P&L. Drawings are not considered an expense but are recorded separately in the Balance Sheet as reductions to the owner’s equity.
Loan Repayments: While interest on loans shows up as an expense on the P&L, the actual loan repayments (the principal amounts) don’t. Loan repayments affect your cash flow and are recorded on the Balance Sheet instead.
Asset Purchases: When you buy major assets like machinery or vehicles, these aren’t considered immediate expenses. Instead, they’re recorded on the Balance Sheet as assets and depreciated over time, with only the depreciation expense appearing on the P&L.
Owner Contributions: Any funds you invest into the business are also recorded on the Balance Sheet and won’t appear on the P&L. These contributions impact your overall equity, not the business’s profitability.
Taxes: Not all tax-related items appear on the P&L. For example, while income tax may show up, GST or PAYG withholding from employee wages are recorded as liabilities on the Balance Sheet and affect cash flow rather than net profit.
Our MJA BAS clients receive quarterly P&L comparison reports and accompanying graphs that show current year to date results alongside the same period from the previous year. This comparison allows you to see whether your revenue, expenses, and profit are improving year over year, helping you spot trends or issues early.
The Balance Sheet
A Balance Sheet provides a snapshot of your business’s financial position at a specific point in time, showing what your business owns (assets), what it owes (liabilities), and the value left for the owners (equity).
Key Components of a Balance Sheet:
Assets: This is everything your business owns or controls that has value.
Current Assets: Cash, accounts receivable (money owed to you), and inventory that can be converted into cash within a year.
Non-Current Assets: Long-term items like equipment, vehicles, or property—assets that will be used by the business over several years.
Liabilities: These are debts or obligations that your business needs to pay back.
Current Liabilities: Short-term debts due within a year, like accounts payable (bills you owe to suppliers) and taxes owed.
Non-Current Liabilities: Long-term debts, like loans or mortgages, that aren’t due for repayment in the next year.
Equity: This is what’s left for the owners once all liabilities are paid. It includes initial capital investments, retained earnings (profits kept in the business), and drawings (money taken out by owners).
What the Balance Sheet Doesn’t Show
While the Balance Sheet provides a valuable overview of your business’s financial health, it doesn’t show everything. Here’s what it doesn’t include:
Business Profitability: The Balance Sheet shows your assets and liabilities at a point in time but doesn’t show whether your business is making a profit or loss over a period. To see profitability, you need the Profit & Loss Statement.
Cash Flow: While the Balance Sheet includes cash on hand, it doesn’t show how cash flows in and out over time. The Cash Flow Statement provides this information, helping you understand how money moves within your business.
Detailed Asset Values: Non-current assets are often shown at depreciated value, not their original purchase price or current market value. For example, equipment purchased three years ago may have a lower value on the Balance Sheet due to depreciation, even though it’s still functioning well for your business.
Operational Details: The Balance Sheet doesn’t reflect day-to-day activities or the performance of individual products or services. For this, you’ll need to look at management reports or review the P&L for insights into revenue and expenses.
Owner’s Personal Finances: The Balance Sheet shows the financials of the business itself, but it doesn’t include personal assets or liabilities of the business owner(s). Owner contributions to the business or personal drawings are included in equity but do not cover overall personal wealth.
Key Indicators to Review Each Quarter
When reviewing your P&L and Balance Sheet each quarter, here are some important metrics to focus on:
Gross Profit Margin (P&L): Gross Profit / Revenue. This shows how efficiently your business produces goods or services.
Net Profit Margin (P&L): Net Profit / Revenue. This shows overall profitability after all expenses.
Current Ratio (Balance Sheet): Current Assets / Current Liabilities. This measures short-term liquidity—ideally, it should be greater than 1.
Debt-to-Equity Ratio (Balance Sheet): Total Liabilities / Equity. A lower ratio indicates less risk, while a higher ratio can signal potential debt management issues.
Year-to-Year Comparison: Reviewing revenue, expenses, and profit compared to the previous year’s quarter helps you identify growth patterns or areas that need adjustment.
Essential Reports for Understanding Your Business and Making Informed Decisions
To fully understand your business’s financial health and make smart decisions, it’s crucial to rely on a few key reports. Each provides different insights into your business, and together, they give you a comprehensive picture.
1. Profit & Loss Statement (P&L)
The Profit & Loss Statement, or Income Statement, shows your revenue, expenses, and net profit over a specified period (monthly, quarterly, or yearly). It answers the key question: Is my business profitable?
Use for: Assessing profitability, identifying cost-cutting opportunities, and tracking revenue growth over time.
Key Insights: Revenue trends, expense breakdown, and overall net profit or loss.
This report is vital for day-to-day financial decisions, like adjusting pricing or managing expenses.
2. Balance Sheet
The Balance Sheet provides a snapshot of your business’s assets, liabilities, and equity at a specific moment in time. It answers: What is the net worth of my business?
Use for: Evaluating financial stability, assessing liquidity, and understanding how assets are financed (debt vs. equity).
Key Insights: Total value of assets, outstanding debts, and net equity.
This report helps you understand your long-term financial position, making it essential for major investment or financing decisions.
3. Cash Flow Statement
The Cash Flow Statement tracks all cash inflows and outflows in your business, showing where money is coming from and where it’s going. It answers: Is my business generating enough cash to cover its obligations?
Use for: Monitoring cash liquidity, planning for short-term expenses, and managing debt repayments.
Key Insights: Cash generated from operations, investing, and financing activities.
This report is essential for cash flow management, helping ensure you have enough cash on hand to meet obligations and invest in growth.
Do you know the ins and outs of your cashflow? Are you reviewing this regularly?
4. Budget vs. Actuals Report
This report compares your actual financial performance to your budgeted figures. It answers: How does our actual performance stack up against our financial goals?
Use for: Identifying variances, understanding where you’re overspending or underspending, and realigning goals as needed.
Key Insights: Gaps between projected and actual revenue/expenses, areas needing adjustment.
This report is critical for ongoing financial management, as it allows you to adjust your plans based on real performance.
Are you setting a business budget? Do you want to be?
5. Key Performance Indicator (KPI) Report
KPI reports summarise critical metrics specific to your business, such as customer acquisition cost, gross margin, or inventory turnover. It answers: Are we meeting our operational and financial goals?
Use for: Tracking progress toward specific targets, identifying trends, and measuring efficiency.
Key Insights: Tailored metrics that align with your business goals.
KPIs are essential for long-term strategy and performance improvement, helping you stay on track with both financial and operational targets.
Do you have KPIs setup for your business? Do you need them?
Understanding and regularly reviewing these key financial reports is invaluable to improving your business's performance and profitability. Dedicating time each month to assess these reports allows you to spot trends, identify issues early, and make informed adjustments to keep your business on track. This proactive approach provides clarity on where your business is thriving and where it could benefit from more attention or investment.
When you understand these essential aspects of your financials, you can make strategic decisions that not only improve day-to-day operations but also enhance your long-term direction and stability.
In the long run, staying engaged with your financial reports and keeping your business financially healthy adds significant value. A well-managed, profitable business is more attractive to potential investors or buyers, boosting your business’s worth. By dedicating time to understanding these financial areas, you’re setting your business up for sustainable growth, increased profitability, and a higher valuation—valuable outcomes for any business owner.
If you’re ready to take a closer look at your business’s financial health and make informed decisions for growth, we’re here to help. Our team can guide you through your reports, identify areas for improvement, and provide expert advice tailored to your goals.
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