With the business environment becomes ever more increasingly comparative are small businesses able to compete and grow. Many challenges small businesses have is the lack of Financial Skills to propel them in the right direction of growth. In this day and age financial skills have become more important that knowing your trade as these skills can determine if your business floats or sinks.
Now we have devised fundamental questions and list of very important information that is required to help the small business owner understand the importance of financial skills.
What is an Income Statement or Statement of Comprehensive income and profit or loss?
The income statement or statement of comprehensive income and profit and loss presents historical data of transactions that have already take place in the business based on the operation of a business for an accounting period which is 12 Months.
The Income statement is divided into sections namely the income section and the Expenses section and therefore the operations of the business can be described by the equation:
Revenue- Expenses = Net Income or Net Loss
On the income statement it presents the equation in more details and in a generally accepted format that is user friendly and understood. Income Statements may differ depending on the business nature (type of Business) and Size.
Revenue is usually derived by selling goods or providing services to customers.
Expenses can be identified as cost that incurred by the business in the process of generating income.
So in other words Revenue contributes to making a profit and expenses reduce profit.
The accounting profit or loss that is calculated is based on the accounting concept of matching and in no way represents the cash or money in the business.
What Is a Balance Sheet or Statement of financial Position?
The balance sheet or Statement of financial Positioning reflects the state of affairs in the business at a particular time/period. The balance sheet has 3 distinct headings these are Assets, Liabilities and Equity of the owners. It generally reflects what the business owns and owes at a specific time or period.
One can easily look at the balance sheet using the following formulae:
What the Business Owns = Assets (How Money is used)
What the Business Owes= Liabilities (Where the money came from)
So generally speaking the balance sheet shows what assets the business has and using and how these assets were funded.
The data and classification of the balance sheet will differ depending on the nature (type of Business) and size.
What is a Cash Flow Statement?
The Statement of cash flow summarises the flows of cash in a business the inflow of cash and the outflow of cash.
There are 3 categories in a cash flow statement namely:
Operating Activities: this measures the cash used for operations in a business were cash received from sales of good or services and less cash paid for goods and services.
Investing Activities: this measures the investments the company makes like the purchasing of Property, a plant or equipment and which usually present ongoing usage of cash.
Financing activities: This measures were the business gets its money from whether it is short-term or long- term financing or from equity and also measures the cash used to pay dividends to directors or shareholders of the business.
Why is this Information Useful?
When a business is operating for over 2 years and need to get a loan from a bank all these statements need to be presented to the bank and they are presented in the form of financial statements. Financers (Borrowers) will need to see these financial statements to determine whether the business is operating efficiently and has the ability to repay the debt.
When one thinks of growing or expanding business you have to look into all alternatives rather than just saving money to expand as this will take time, businesses need to borrow money whether it is from Investors or Banks and Financial Statements that contain all the above mentioned statements will help you convince and influence the two to give/finance your project or business.
The Financial Statements through the above mentioned Statements will be representing the health and capability of our business and through them you will then know the direction of your business and its performance comparing it every year to measure growth of your business.
The term liquidity means being in cash or assets easily convertible to cash.
These ratios measure the ability of a business to cover its current liabilities (current Borrowings) out of its current Assets.
- Current ratio- shows the extent or ability of a company to pay of its current Liability (Current Borrowings) out of the income or profit of its current assets.
The formulae: Current Assets/ Current liabilities
Depending on the type of business you are in the current ratio of 2:1 is regarded good as it would show that you assets can pay off your current debts.
- Quick Ratio- the ratio measures the company’s ability to pay off its current liabilities out of its immediate current assets that can quickly be converted into cash when there is an urgency to pay creditors.
The Formulae: Current assets- Stock/ Current liabilities
When you company has an acid test of above 1.1 it passes the acid test, as there will be no doubt that the company can meet its current liabilities on short notice.
- Gross profit margin
This is used to measure the cost price of the good produced or sold against the selling price of that product, this is commonly known as a mark-up.
The formulae: Gross Profit/ Sales x 100
In order to determine that the gross profit is on the right level or measure if sales are increasing in the company you have to compare the Gross Profit margin to the previous year, any signs of stagnation and lower percentage than the previous year means that the company I not performing. This can be a good indicator to measure if there is growth in the business.
- Net Profit Margin
This measures profitability after all Incomes and Expenses have taken place, including non-operating items and income taxes.
It is very important to compare the net profit margin to the gross profit margin as the gross profit margin can be increasing every year the net profit margin can be decreasing of which shows that the company can control its cost of sales but cannot control its overheads (costs to maintain or run the business) and salaries. So it becomes very important to use these calculations to measure the performance of your company.
The Formulae: Net profit after tax/ sales x 100
- Return on Assets
This ratio is also known as the return on Investment and it indicates the amount of profit earned by a company in comparison to the level of investment in the assets.
It measures the level of efficiency that the directors of the business used the assets of the company to make as much profit as they could with the assets. Income is earned by using the assets of the company productively.
- When this ratio is performing well it shows funders or investors that management of the business are working efficiently to maximise profit of the business and makes the business more attractive to more investors and financers.
The Formulae: Net profit after tax/ total assets x 100
These particular ratios were chosen specifically to help small businesses identify places of improvement in their business and to know what lenders such as Banks and other institutions that borrow money look at and consider before borrowing money to your business.
Investors also look into these financial ratios to see the performance of your business and potential growth. There are many other financial ratios but we have specifically chose these to help grow your small business as they are relevant and easy to familiarise yourself with them.