Numbers are the language of business so if you tend to shy away from them it’s time to face your fear and learn to love your accounts. Here are some tips for understanding your business numbers and using them for your decision making.
1. Are You Making Money?
You can check if your business is profitable by looking at the profit and loss account. scroll down to the bottom figure which will show a profit (positive figure) or a loss (negative figure).
Then look at the top figure (the sales) and quickly glance through the list of expenses.
Take the bottom figure (let’s assume its £15,000 profit) and divide it by the top figure (assume £100,000 sales). This will give you 0.15 which means for every £1 of income, you are generating 15p in net profit.
How does the £15,000 profit compare with what you had in mind? And does the 15% net profit margin deliver the right return for you?
2. What state is the business in?
Does the business have a positive balance sheet value? You find out by looking at the balance sheet statement which shows what your business has and what it owes. Scroll down and make a note of the last number. It’s normally called capital and reserves. Is that figure positive or negative? A positive figure means your business has some value.
A negative figure is a red flag. Start by taking action to improve profits!
When looking at your balance sheet ask simple questions like; is this how much I owe my creditors? is this how much my customers owe me? If the amount your customers owe you is higher, get the debtors list, review and start making calls.
3. Where is the cash?
Say your profit figure shows £15,000 but your bank balance is only £3,000. Where did the £12,000 go? Another financial statement, the cashflow statement reconciles your cash to your profit. But if you don’t get this here’s what to check:
Have your customers paid you late?
Have you drawn more money or dividends out?
Have you paid your suppliers early?
Have you purchased some equipment?
If you answer yes to any of these, that may be where the £12,000 is sitting.
4. What do the trends reveal?
Compare the current year or the current month’s figures to the previous year or month to make sure you are progressing towards your milestones and to spot any anomalies.
Nearly every business decision you make turns into a number. If your phone costs have gone down by 30%, compared to last year, ask yourself why. What’s the story behind this number? Is this because of the cost cutting decision you made a year ago? Or the change in tariff decision? Trends are your friends.
5. What’s your gross margin?
Gross profit margin is an important number to calculate. The next time you get your accounts, take the direct costs of sales or direct expenses (variable costs) from the revenue. Then divide that number by the revenue. That is your gross profit margin.
If your revenue is £100,000 and your materials or direct labour or direct expenses are £70,000: the difference of £30,000 divided by £100,000 revenue gives you a margin of 30%. So, for every £1 of sale, you’re making 30p in gross profit. This tells you how profitable you are at the gross margin level and whether your business model works.
Here are two red flags. If you’re making £30,000 in gross profit but your fixed costs are £35,000, something needs to change. If your margin is far below the industry average, you need to understand why and take corrective action.
6. What Is Your Breakeven Point?
The reason you need an idea of your breakeven number is so that you know how much income to make to cover all your costs.
How do you get this number from your accounts? You will need your total fixed costs. These are the costs that do not change regardless of the amount of sales you make e.g. rent, admin team costs, rates. In your profit and loss account, it should be most items listed under admin expenses (do watch out for any variable costs that find their way under admin costs).
You then need the gross profit margin. You divide the total fixed costs by the gross profit margin and this tells you the amount of sales you need to make at any given period to cover all your costs.
7. How Much Is Your Business Worth?
You now know how to get and make sense of your profit figure. You also know what to look out for when you review your balance sheet and the meaning of the balance sheet value. And how to look out for the cash drain in your business. Did you know that these give you a starting point in measuring the value of your business?
Healthy profits, good cashflow and positive balance sheet values are all good signs of a valuable business. Of course, there are many other factors to consider when valuing your business and other key drivers of business value. However knowing how to read your accounts and what the numbers mean certainly puts you in a pole position. It also helps you make the right decision with regards to building the value of your business.
I hope the information above will help you make sense of your numbers. There are other key numbers to review so it is important to have regular sessions with your accountant and ask plenty of questions. That way not only will you understand your numbers you’ll learn to love them as they help you with your business decision-making.
ABOUT THE AUTHOR
Jonathan Amponsah CTA FCCA is an award winning chartered accountant and tax adviser who advises entrepreneurs on business improvement and tax optimisation. Jonathan is the founder and CEO of The Tax Guys.