Understanding your financial statements – Xero Accountants, Virtual FD and Business Advisory Empowered Finance

Understanding your financial statements

I believe that every business owner should understand their financial statements and the main components of them. I’m not expecting you to become an accountant but at a minimum, you should understand what the statements are for, what the important things to look at are and what the potential warning signs are.

I appreciate that readers will have differing levels of financial acumen. For those of you who are already comfortable navigating your way around your financials, I suggest you scan through it anyway just in case there are any nuggets of information in there for you. You wouldn’t drive your car with your eyes closed so why run your business without
opening your eyes to your financial performance?

There are three main financial statements, which are all interlinked. I have summarised them below rather than go into great detail. If you need further explanations I suggest you sit down with your accountant and ask them to walk you through each of these until you are comfortable with what each one is and how it works. And if you don’t have this information, or your accountant is unable or unwilling to provide it then it may be time to look for a new accountant.

Profit and Loss

This is the first (and sometimes only) financial statement that most agencies look at. It shows your sales, your costs directly associated with making those sales, your overheads (other costs such as rent) and your profit. For any given month it is
beneficial to have the actual figures, preferably tracked against a budget, along with commentary explaining what has happened and why.

Balance Sheet 

Shows the balance of your assets; typically cash, trade debtors (clients who owe you money), fixed assets (such as
computer equipment) and your liabilities; typically bank loans, trade creditors (suppliers you owe money to), HMRC (for VAT, national insurance). In a healthy business, the assets are greater than the liabilities and the amount of cash at any given time will be at least three months of working capital.

Cash Flow

Arguably the most important and least used financial statement. The biggest cause of agencies going out of business is
due to running out of cash and the biggest stress for owners is worrying about having the cash to pay salaries and the taxman. 

But sales, profit and cash are not the same thing. There is a much used saying

 “Sales is vanity, profit is sanity, cash is reality”. 

It could be anywhere from 7 days to 3+ months from the date you issue the invoice to the date you get paid. During that period you still need to pay salaries, pay rent, pay HMRC. A cash flow statement shows your opening cash position at the
beginning of the month, the cash inflows and outflows relating to your operating activities i.e. the day to day running of your business as well as cash inflows and outflows relating to buying or disposing of assets and servicing any loans to show your closing cash position at the end of the month.