Reading financial reports doesn’t come naturally to most business owners. Let’s be honest, numbers on a page, such as those you print from your financial software can be difficult to understand if you haven’t completed a business or accounting degree, and truthfully, not everyone wants to be an accountant – and that’s ok. You don’t need to be an expert, after-all that’s why you have advisers help you navigate your business, but you should be interested in growing your basic financial literacy and understanding of what goes into producing results in your business. Not only do you feel more confident but over time it will also change the types of conversations you can have with your adviser, meaning you can extend the type of advice they give you.
Here’s the thing though, finance and accounting can be like learning a new language, or more so, learning to ‘read’ a new language, so why does it have to be so difficult? The good news is, it doesn’t.
Think back to when you were learning to read at school, all those years ago.
When children learn to read, they start on simple, often one syllable words and we accompany those words with pictures that help and guide them. The same can be done for financial data when reading financial reports, we’re going to share with you some simple visuals that will help you to better understand and breakdown the financial data you currently have.
To start with lets take a basic Profit and Loss
Typically there are three components that make up the Net Income or Profit in the Profit and Loss Statement
- Revenue : income of the business
- Cost of Sales : expenditure that are directly related to producing income
- Expenses : business overhead costs
These all form a part of ‘Profit’ the calculation is
Revenue – Cost of Sales – Expenses = Profit
Take a look at the visual below – can you see how each of these components work together to get to Profit?
- When there is negative profit, or a loss, you should be able to see that income was less than cost of sales and expenses added together.
- When there is profit, you should be able to see that the profit portion adds onto the cost of sales and expenses to equal total revenue.
What else can you see in this graphic?
- You might be able to see that in this case the Cost of Sales (blue) is relatively the same each month. This could lead to you to asking why the cost of sales doesn’t fluctuate with the sales revenue? That’s a really good question, the answer in this situation is that this data is a service based business, and their main cost of sales is wages. Instead of grouping all wages together they have separated wages that relate directly to sales delivery and classified as a cost of sale.
- You also might be able to see that there is an ‘average’ calculation for both Cost of Sales and Expenses – we can use the sum of this to work out what average sales we might need to ensure we can cover all our costs each month.
- You can also see that Income fluctuates up and down, it’s easier to recognise which months have low sales, you could use this to work out a strategy to increase sales in these time periods.
- You can see that April and May are the most profitable months, in fact the majority of the business’ profit is made in these months, with most other months having losses or small profits. This means that this business also needs to keep a close watch on cash flow, they need the cash generated in April and May to sustain them through other part of the year.
So one simple visual representation of a profit and loss statement can tell you a lot about a business.
We’ve put some articles together to explore some case-study data to show how you can use visual representations of data you already have makes reading financial reports easier and leads better business decisions. We’ll show you how you can read the story within your business and write the next chapter using strategy. You see, every decision and action you take in your business eventually ends up showing on the financial statements, knowing how to use the past to write your future is how to decide which strategy to implement.