Starting a business can be daunting. Especially with the added responsibility of managing the company finances.
If you are a Limited Company or Limited Liability Partnership (LLP), you are required to submit annual accounts to Companies House. You’ll also be required to submit a company tax return to HMRC if you’re a Limited Company. Failure to do so results in fines and increased likelihood of inspection – which we all want to avoid. If you are a sole trader, you must submit your self-assessment tax return every year, again you will incur a fine if you are late.
The following three tools; profit and loss, balance sheet and cashflow forecast help you monitor the financial activity and performance of your business. They help you make informed decisions and are a source of information to external stakeholders.
A Cashflow forecast shows how money flows in and out of your business. In comparison to a profit and loss, which typically links revenues to the associated costs, not recognising when payments are made.
Cash management is critically important for a person running a business. Maintaining a Cashflow forecast requires you to know when income is expected to come in and when costs and expenses are to be paid.
This forecast is detailed over a set period, such as a quarter or a year and allows you to forecast your bank balance, managing the cash. It allows you to identify when gaps may occur, and surpluses that may happen.
Profit and Loss
A Profit and Loss account shows income, costs of goods/services sold, and expenses during a set period. It clearly breaks down how the business generates a profit.
The profit and loss account calculates two different profit figures, the first is Gross Profit:
Gross Profit = Income – Costs of goods /services sold
Gross profit is the amount that a business earns from the sale of goods or services before all other expenses have been deducted. In other words, gross profit represents the amount of value gained from the sale of a product or service.
The second is Net Profit:
Net Profit = Gross Profit – Expenses
Net profit provides the amount earned after deducting both the cost of good/services sold and other expenses such as operational and overheads -payroll, tax, and interest.
Effective profit and loss management involves analysing the performance of the business over various periods. Many businesses incur seasonal changes, such that, reviewing the performance of one period in isolation won’t tell you much. Performance should be compared to budgeted performance and prior periods.
The profit and loss statement allows you to dig deep into the revenues, costs, and expenses of the business. You can identify the cause of the changes in profit and remedy them directly.
A Balance Sheet shows the value of a company. It shows the company’s assets (what the company owns), liabilities (what the company owes), and equity (shareholders investments) at a set point in time.
A simple formula:
Assets = Liabilities + Shareholders equity
The balance sheet shows a cumulative summary of the company, it can be compared to prior periods to identify how the company has changed over time. It shows the net assets of the business, breaking down the components making it up, for example, cash in the bank, debt, outstanding invoices and so on.
It is used to calculate the state of the company’s finances useful for investors, suppliers, lenders and so on. For example, a lender will use this information to determine whether a company qualifies for additional credit or loans.
All three statements are linked to each other and as such are best used together. It is fundamental that you are in control of your business’s finances; that you are successfully managing the cashflows, you know where the money is coming from and going, and ultimately maintaining a healthy business. You can get started with these on your own, but if you are not confident, seek help sooner rather than later.