By understanding your financial documents you’ll have a better idea of how your business is performing, keeping you in control of your company. Your profit and loss statement shows how much you're making (and what tax you owe) and your balance sheet shows the financial viability of your business.
Your balance sheet shows your financial strength. This is normally prepared at the end of a financial quarter or a full accounting year.
It’s a cumulative record of what’s happened in your business right from the start and summarises your assets (what you own) and liabilities (what you owe). The difference between the two is what your business is worth.
The assets side of your balance sheet includes:
The liabilities side of your balance sheet includes:
The capital figure in your balance sheet will always equal fixed assets, plus current assets, less current liabilities.
Your balance sheet is a summary of your business performance, and lets you compare your performance with past years. This lets you see any trends that develop. It contains information that gives you an indication of the health and profitability of your business. These are called key performance indicators. Some examples of these indicators or ratios include:
Your business adviser or accountant will be able to tell you which key performance indicators you should monitor. By comparing key ratios with other businesses, and against the same figures for previous periods, you can identify areas where you need to make changes.
Your business’s trading performance is shown by your profit and loss statement. It deals with a defined period, such as a month, a quarter or financial year. It records sales, expenses, profits and losses, and any tax payments made during the period. It returns to zero at the end of each financial year, recording sales and expenses for a fixed period of time only.
A profit and loss statement typically follows this format:
Your profit and loss statement can reveal trends in your gross profit and net profit margins, and let you make changes before things become critical to your business.
You calculate your gross profit margin by showing your gross profit as a percentage of your turnover. If you have turnover of £2 million and cost of sales of £600,000, you’ve made a gross profit of £1.4 million. As a percentage this is 1,400,000 ÷ 2,000,000 x 100 = a gross margin of 70%.
So every £100 of sales you make generates £70 towards expenses and towards your net profit. If your gross margin percentage starts to slip you need to find out why, and make changes to stop the erosion of your profit margin.
The reasons may include:
Your net profit margin shows, as a percentage, your net profit (gross profit less fixed or indirect costs) to turnover. If your business had a £2 million turnover and a net profit of £300,000, the net profit margin would be £300,000 ÷ £2,000,000 x 100 = 15%.
If you notice your net profit margin falling, it means you’re paying proportionately more in expenses than previously. It can also help you spot other problems. If your turnover increases from £2 million to £3 million and your net profit goes up from £300,000 to £400,000. This looks good until you look at your net profit percentage: £400,000 ÷ £3,000,000 x 100 = 13.3%. That means your net profit margin has actually dropped from 15% to 13.3%. It shows that even though your turnover has increased by £1 million, and your net profit by £100,000, you’re not making as much profit from that increased turnover. You can then investigate what’s causing the reduction in the profit margin and make changes to stop the slippage.
There are two ways you can get a clearer picture of your performance — using your gross and net profit margins as benchmarks.
Make sure you know how to read your key financial documents and you’ll be rewarded with better money management skills.
This guide is intended as general advice only, and not intended to cover specific circumstances and needs. The information in this article is also not linked to any of the products offered by Clydesdale Bank PLC.