KeyPlay Business Solutions

Key Indicators:  Goals For Your Business !

Step 5. is to have benchmarks and goals for your business. In simple terms think about sport. Remember the year your team won the grandfinal or made it to the finals ? I am sure you do and you will also remember your coach said to run faster, be stronger, quicker and think smarter.  

• How fast did I run ?
• What distance did I cover ?
• What weight did I lift ?
• How many turnovers did we make ?
• How many goals did we shoot  ?
• Who is the best team ?
• Who are the best players ?
• What was my statistics ?

Questions like these are simple and we all discuss them all the time. When our Kids play sport for example. But you will notice the answer to these questions involves basically two ideas.

1. MEASUREMENT OF A RESULT
2. AGAINST A BENCHMARK 

"Measure the activities of your business's output, against a set minimum standard"

UNDERSTANDING YOUR BUSINESS:

When you go into business on your own, you do so to market a product or sell a skill and chances are that skill has little to do with accounting.

As a small business owner you are passionate about your dream, your product, your service and your customers and as a result, keeping your accounts in order can come in very close to the bottom of your priorities.

While it is easy to contract your accounts work out to a virtual assistant or an offsite bookkeeper, as a responsible small business owner - and to ensure you are a successful one - you still need to understand the basics of your business accounts and systems.

Understanding Your Accounts
It may be enough to make business decisions based on intuition in the beginning, but making fully informed decisions based on financial facts has the ability to set you apart from the failed small businesses which have fallen by the wayside.

"Instead, make sure you understand and can monitor the financial position of your business without having to run to your accountant every time you need information".

This means being able to compare the financial performance of your business with the targets you projected at the beginning of the financial year or quarter. You should also be able to review the growth and progress of your business in recent years, and make comparisons with business benchmarks in your industry.

With this information on hand you have an accurate picture of how well your business is really doing, rather than just a vague feeling from the number of enquiries and the value of invoices you have sent out this week. Plus, if you regularly manage and update your financial statements you will know that you are satisfying your legal record keeping obligations as well.

Compiling and managing this information will be done through two main financial statements, your profit and loss statements and your balance sheet. However, this is just part of the process because you also need to understand how to analyse these financial statements.

To analyse your small business statements:
Convert the information into ratios or percentages.
If you compare the dollar values on your small business financial statements you are not getting a true picture of how your business is developing as these figures do not allow for inflation, and make it harder to compare your business to industry benchmarks.

Create a benchmark for your ratio comparisons.
A ratio won't mean anything unless you have something to compare it to, and your benchmark may be a comparison of how your business performs at different times of the year, or how it compares to industry figures. In this way you can monitor whether there is a change.

The Importance of Understanding Your Accounts
You can judge the liquidity of your business.
This allows you to see whether your business can keep up with its outgoing expenses and pay bills on time from a cash resource.

You can calculate your business profit.
You can do this by comparing the percentage of your net profit, to your total sales.

You can identify problems and find solutions.
It is easier to fix a problem in your business if you do so before it happens; even if you see a problem arise in your regular analysis, your familiarity with your business systems, cash flow and statements will give you the best chance of finding the best solution.

Understanding the Profit and Loss Statement
Your profit and loss statement can be generated to show the performance of your business over a chosen time period. You can view the financial situation of your business monthly, quarterly, annually or over a customised period.

Since the profit and loss statement shows the income less the expenses in your business, it is a popular tool with small business owners who want to track their progress. However, before you rely too heavily on your profit and loss statement, make sure you understand what you're looking at.

Profit and loss statements are not a compulsory part of a tax return for sole traders, partnerships or small proprietary companies but can be a useful tool to help you review the financial performance of your business, on paper, in black and white. Your accounting software program should be able to automatically generate a profit and loss statement, or you can ask your accountant or bookkeeper to show you how.

Your profit and loss statement will show:

Your business' revenue.
The revenue of a business is the money earned from the normal business operations, including selling goods and services, interest earned on savings or dividends on investments. Your revenue may also include any rebates your business receives or rent due to you.

The cost of goods sold (COGS).
The COGS for your business includes all costs you must pay to acquire goods for sale. This includes the actual purchase price, any import duties, non-reclaimable taxes, freight inwards, freight insurance, handling, labour and any other costs you endure to convert materials into finished goods for sale.

Your business' gross profit.
This equals the difference between your sales and your cost of goods. A larger gross profit margin means a healthier business operation as you are retaining a higher percentage of the sale, and losing less to your suppliers.

Your business expenses.
Included in your business expenses is every cost you incur to earn your business revenue including wages, rent, accounting and legal fees, electricity, depreciation and interest on business loans.

Your business' net profit.
Your net profit is calculated by subtracting your expenses from your gross profit.

If you are a sole trader, the net profit is calculated before your own drawings are taken out, if your business is a partnership net profit may be calculated based on the proportion of the business allocated to each partner. As a company the wages of an active director are considered an expense and net profit for shareholders or dividends is calculated after this expense has been deducted.

In the case of a service business, you do not have to make a gross profit calculation as there are no goods costs involved.

Benefits of Reviewing Your Profit and Loss Statement Understanding the basic components of your business finances.
A profit and loss statement will show you the cost of the goods or services sold, your gross profit and your expenses. Each of these components influences your net profit so you can pinpoint the differences a change to each component would make to your end profit.

Knowing how much money you are making.
When you're on a wage in traditional employment, you know how much money you're making, because it's the same each week. However, in a small business you often have to look at a slightly bigger picture and this is where a monthly or quarterly profit and loss statement can show you how much, if anything, you are making.

Comparisons and forecasts.
You can use the information in your profit and loss to see how your actual performance measures up to your projected business outcomes, and how it fares against industry benchmarks. You can also use past figures to project future income and net profit.

Proof of income and expenses.
A profit and loss statement will sometimes be accepted in conjunction with other documentation if you are applying for a loan or a mortgage. You can also use the information to calculate your income and expenses to make it easier to complete your tax return.

Analysing Your Profit and Loss Report
To analyse the information in your profit and loss report, you can use profitability ratios so you can be sure your business is as profitable as it should be, where an increase in the ratios shows a positive trend for your business. Use the following ratios to analyse your profit and loss statement:
Gross profit margin ratio.
Your gross profit is your income, less the cost of goods sold. Your gross profit margin ratio is therefore your gross profit divided by your income. To express your gross profit margin as a percentage, calculate your gross profit divided by your income, multiplied by 100.

Net profit margin ratio.
Your net profit margin ratio is your net profit divided by your income. To express your net profit margin as a percentage, calculate your net profit divided by your income, multiplied by 100.

A break even analysis allows you to calculate the number of units for break even in your business. The number of units is calculated by dividing the total fixed costs of your business, by the unit selling price less the variable unit cost.

To calculate the dollar value divide the total fixed costs, by the total variable costs divided by total sales.

Your Balance Sheet
Your balance sheet will allow you to evaluate the liquidity of your business so that you can instantly identify and understand your business' financial strength, and its capabilities in moving forward. A balance sheet is included in reports to business owners, stakeholders, banks and investors but is not compulsory as part of a small business tax return.

You need to understand your balance sheet because it tells you:

The proportions of your assets and liabilities.
Your balance sheet will detail what your business owns and what it owes showing the business assets and liabilities as well as the value of your equity, or the net worth of the business - the difference between what you own and what you owe.

Your business' financial strengths.
You can see the capabilities of your business with regards to its financial strength through liquidity and the business' ability to pay debts as they are due.

Understanding Your Balance Sheet
To understand your balance sheet you will be looking at the areas of assets, liabilities and owner's equity. Your assets and liabilities are divided into short term and long term and can be further divided depending on the type of business into:

Assets.
These are the resources your business uses to remain in operation and an asset is any item which contributes to revenue. For example, cash and inventory are considered to be current assets as they are likely to be consumed within 12 months, whereas property or vehicles are non-current assets as they are not expected to be liquidated in the next 12 months.

Liabilities.
These are all financial obligations of the business, and are owed to those outside of the business. Current liabilities such as accounts payable are expected to be repaid within 12 months, where non-current liabilities such as business loans are not expected to be settled within 12 months.

Owner's equity.
This is the net worth of the business and is the value of your business assets, less your business' liabilities. This is the amount which belongs to you, after all financial obligations are met.

Analysing Your Balance Sheet
You can now analyse the information on your small business balance sheet, in conjunction with the details from your profit and loss statement and the following ratio calculations.

Debt to equity ratio
Debt to equity ratio = total liabilities divided by the owner's equity

Your debt to equity ratio will tell you how heavily you rely on debt to finance your business operations, the higher the ratio, the greater the reliance.

Liquidity ratio
Liquidity ratio = current assets divided by current liabilities

Your liquidity ratio is an indication of how well your business can meet short term bills and expenses and the higher the ratio, the better your liquidity.

Efficiency ratios
The efficiency ratios of your business show how well you manage the business assets, and how quickly you can convert non-cash assets into cash assets. This is calculated using the following ratios:

Accounts receivable turnover ratio = total sales divided by accounts receivable. The higher your ratio the faster your business is able to collect payment on invoices, meaning more cash is available.

Accounts payable turnover ratio = cost of goods sold divided by accounts payable. You are looking for a high ratio as this shows there is a shorter period between receiving goods and paying for them so you rarely pay your bills late.
Inventory ratios
You want to see a high inventory turnover as this means high demand for your product, so calculate your:

Annual average value of inventory = (opening inventory + closing inventory) divided by 2. Then calculate:
Inventory turnover ratio = cost of goods sold divided by annual average value of inventory.

Final Note
Your small business accounts needn't be confusing and having a basic understanding of your profit and loss statements and your balance sheets will not only help you make informed business decisions about your future, it will also give you a feeling of achievement and pride in seeing your business success on paper, in undisputable figures.

 Click here to download Tools, Forms & Templates to implement step 5 - Key Indicators.

Call us if you have any questions - Jamie Johns