Are you unsure what financial information you should be looking at? Overwhelmed by too many numbers and reports? This blog will help you focus.
Running a small business comes with a lot of moving parts, and keeping track of your finances is one of the most important. But it can be hard to know where to start. Knowing a few key financial basics can make a big difference in setting your business up for growth and success.
In this blog, I’ll cover the basic financial information that you should understand if you run a small or medium sized company.
#1 - Income and expenses
The financial health of your business comes down to two main things: how much money you are brining in (income) and how much you are spending (expenses). Keeping track of both on a regular basis is essential.
Income: it's important to know where your income is coming from, so that you can understand what is working, and identify areas that might need improvement. For example, look at your monthly sales by income stream and notice how it varies month to month.
Expenses: tracking what you are spending your money on helps you to understand where your money is going, leading to better decision making. It's a good idea to know the split of your fixed costs (e.g. costs that you'll incur every month regardless of your sales, such as rent and payroll costs) versus your variable costs (e.g. costs that vary with your sales, such as subcontractors, cost of sales), so that you know how much income you need each month to cover the fixed costs.
Reviewing your Profit & Loss account (P&L) should help you understand your income and expenses. If you're using Xero accounting software, you can easily drill into the various numbers on the P&L, to see what transactions are behind them.
#2 - Cash flow
Cash flow is one of the most critical aspects of your business’s finances. It’s the movement of money in and out of your business over a period of time.
Positive cash flow means you have more money coming in than going out, while negative cash flow means the opposite.
Remember, even if your business makes a profit (it's income is more than the expenses), poor cash flow can lead to serious problems. You need money in the bank to be able to pay the bills and those bills might not come at the same time as the income.
Don't get caught out by quarterly VAT bills or annual Corporation Tax payments.
Regularly reviewing your cash flow and thinking ahead, helps you plan for any potential shortfalls and ensures you always have enough cash in the bank to cover your expenses.
#3 - Balance Sheet
The Balance Sheet is often less understood by business owners than the P&L, but it's just as important.
The Balance Sheet helps you understand the financial health of your business at a moment in time and reviewing what's on there can help identify transactions that have been mis-posted and need to be in your Profit & Loss account.
It's worth taking the time to understand your Balance Sheet, so that you don't get any nasty surprises when your year end accounts are prepared.
Preparing number of simple reconciliations on a monthly, or even quarterly basis, will help you feel confident that there's nothing lurking on your Balance Sheet.
The only way you can be sure that your Profit & Loss is correct, is to know that your Balance Sheet has been reviewed and reconciled.
#4 - Key Performance Indicators (KPI's)
KPI's will vary for each business, but here are 3 that are relevant for the majority of businesses:
Operating Profit Margin % - this is your operating profit divided by your sales. It shows you what % of income is left after you've paid your expenses. It's a good idea to track this each month to help you understand how your sales and expenses move throughout the year.
Debtor Days: how long does it take your clients to pay you. Track this month by month and compare it to the average terms you give your customers. If you spot the days increasing, you might need to focus more attention on your credit control.
Creditor Days: how long do you take to pay your suppliers. Compare this to your Debtor Days - if your Debtor Days are higher than your Creditor Days, you could look at whether you are paying sooner than your supplier terms. If so, why is this? It's always better to have the money in your bank account, than someone else's!
There are lots of other KPI's you could track, and what's relevant for you will depend on your business sector. For example: your gross profit margin %; your payroll % of sales; your customer acquisition cost; your stock turnover days.
Wrapping up
Understanding this basic financial information - income and expenses, cash flow, balance sheets, and KPI's - can help you run your small business more effectively. You don’t need to be a financial expert, but having a grasp on these basics will give you the confidence to make decisions and keep your business on the path to success.
If you found this post useful, I'd love to know - you can contact me via my Contact page, or via LinkedIn. Alternatively, if you'd like a bit more help and advice, get in touch and 'm happy to have a no obligation chat and answer any other questions you might have.
Keep an eye out for other tips to help you run your SME in a profitable and sustainable way.
My mission is to make finance simple and understandable for business owners.
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