Financial Enlightment – Understanding The Numbers
When running a small business, much emphasis is put on [ominous music….] the ‘dreaded financials’!
These two words are designed to strike terror into the hearts of small business owners everywhere! We are meant to ‘make friends’ with our Financials, to use them to make informed decisions, to feel empowered, and for leverage towards some better, brighter tomorrow! But for many, I’d say the majority, of small business owners, or even just families trying to make ends meet each month, ‘The Financials’ are unequivocally not our friend, do not make us feel empowered, and do not aide in our making informed decisions, because we don’t even understand the b#@!%y things!
Sometimes our accountants do not help, because they make us feel stupid and intimidated, so we try to look bright and comprehending whilst in their sacred realm, only to leave, moan, and feel less bright than ever. Do not despair, help is at hand. Here are the basics:
Financial Literacy 101
Step 1: Put aside your ‘I-feel-like-I’m-back-in-school-and-I-feel-stupid’ cloak, put on your big girl panties and know you can do this.
Step 2: Write down the following:
a) ASSETS are what you OWN. E.g. real estate, cars, plant and equipment, inventory (also called Stock on Hand), debtors (the people who owe you money for goods or services), cash at bank, investments (shares, term deposits, etc).
b) LIABILITIES are what you OWE. E.g. mortgages, credit cards, car loans, equipment loans (also called leases, hire purchases or chattel mortgages), Creditors (people to whom you owe money for supplies).
c) EQUITY is the difference between ASSETS and LIABILITIES; i.e. The amount of ownership you have. For instance Property Value minus Mortgage on property equals your Equity in the property.
d) INCOME is the money you bring in for providing your Goods or Services.
e) COST OF GOODS SOLD (COGS) is only relevant if you on-sell or manufacture Goods; this is the direct cost of obtaining or manufacturing your goods for sale. This includes costs of goods for resale, or components and labour for manufacturing additional items.
f) GROSS PROFIT (only relevant if you on-sell or manufacture goods) equals INCOME minus COGS.
g) EXPENSES are the (other / indirect) costs of providing your goods or services. These include overheads, utilities, staff costs, travel, and so forth.
h) NET PROFIT / LOSS equals GROSS PROFIT minus EXPENSES (for businesses who have COGS) otherwise it is INCOME minus EXPENSES. The resultant figure is the one on which your tax is generally calculated, but there are other factors which can alter this (so seek personalised advice on your tax planning strategy).
i) The PROFIT & LOSS STATEMENT or INCOME STATEMENT shows your business’ INCOME, COGS and EXPENSES, and NET PROFIT for a set period of time (a month, quarter or year).
j) The BALANCE SHEET or ASSET STATEMENT lists your ASSETS, LIABILITIES and EQUITY.
Other relevant terminology to consider would include:
k) SUPERANNUATION: akin to another ‘investment’ you hold and could be managing with expert guidance, to optimise prior to retirement.
l) INVESTMENTS: any means by which you aim to grow your wealth. E.g. term deposits, shares, real estate, etc.
m) SUCCESSION PLANNING: how you intend to pass on your business.
n) EXIT STRATEGY: how you intend to exit your business.
o) ESTATE PLANNING: how you’d like to leave your assets upon death – be aware that businesses need separate estate planning, Superannuation has options for separate estate planning, guardianship of young children must be considered, and Powers of Attorney should be in place for everyone. It is not difficult if you seek expert advice.
p) DEBT REDUCTION / MANAGEMENT: not all debt is inherently ‘bad’; much can depend upon the purpose, the tax structure and other facets; seek expert independent advice to ensure your debt is structured optimally for your circumstances.
None of these are difficult when put into your own personal context. DO NOT Google these terms and expect them to make sense. Find an adviser with whom you feel comfortable, and ask them to explain these terms as they relate to you.