Understanding your financial documents will give you more control and a clearer picture of your business and how it’s performing.
Your balance sheet shows how sound and financially viable your business is. It provides a snapshot of your business’s financial strength at the end of a quarter or a full financial year. It summarises the:
The difference between your assets and liabilities tells you what your business is worth.
On the assets side of your balance sheet are your:
On the liabilities side of your balance sheet are your:
The capital figure in your balance sheet will always equal fixed assets plus current assets less current liabilities.
Your balance sheet gives you a quick summary of your business performance and contains information and figures you can use to measure the health and profitability of your business. These are called key performance indicators (KPIs).
Some examples of these KPIs include your:
Your profit and loss statement shows you how much money you’re making – and the amount of tax you owe. It provides a picture of your business’s trading performance over a defined period, such as a month, quarter or financial year.
A profit and loss statement typically follows this format:
Less cost of sales (your direct costs like raw materials)
Equals: Gross profit
Less fixed or indirect costs (your overheads like rent and salaries)
Equals: Operating profit (your profit before tax)
Less tax payable
Equals: Net profit
Your profit and loss statement allows you to study your gross profit and net profit margins. These can reveal trends that enable you to make timely changes.
Your gross profit margin is your gross profit as a percentage of turnover. For example, if your turnover is £2 million and your cost of sales is £600,000, you’ve made a gross profit of £1.4 million – a gross margin of 70%.
So every £100 of sales generates £70 that goes towards paying for expenses and towards your net profit. If your gross margin percentage starts to slip you’ll have to find out why and take action. The reasons may include:
Your net profit margin compares your net profit (gross profit less fixed or indirect costs) to turnover. For a business with a turnover of £2 million and a net profit of £300,000, the net profit margin would be £300,000 ÷ £2,000,000 x 100 = 15%.
If your net profit margin falls, it means you’re paying proportionately more in expenses than you should be.
If your turnover increases from £2 million to £3 million and your net profit goes up from £300,000 to £400,000, this can look good until you see your net profit percentage:
That means your net profit margin has actually dropped from 15% to 13.3%. Your turnover has increased by a million, and your net profit by £100,000, but you’re actually not making as much profit from that increased turnover.
In this scenario, identify which costs have increased out of proportion to the rise in sales, so you can stop the slippage.
This guide is intended as general advice only, and not intended to cover specific circumstances and needs. The information in this article is also not linked to any of the products offered by Clydesdale Bank PLC.