UNDERSTANDING YOUR FINANCIAL STATEMENTS

reading-financial-statements

Accounting is not usually the primary interest of most entrepreneurs. They are usually passionate about other things that they believe are more crucial to the growth of the business. The implication is that most business owners find it inconvenient interpreting the financial reports submitted to them every month. So long the money is coming in and the bills are being paid, there is no much use for any financial report received.

While it isn’t possible for everyone to become an accountant, there is a lot you can gain from a basic understanding of some accounting principles. You can still learn how to comfortably interpret a profit and loss statement and make strategic decisions to move your company forward. The purpose of this article is not to teach you how to become a pro in accounting. Instead our aim is to help you go beyond just filling financial statement but help you know about what you are filling and their significance.

Principles of financial accounting

Regardless of the kind of business you operate, every profit and loss statements are developed from the same simple accounting formula:

Profit = selling price – cost price

Your profit is the result you get after you must have subtracted cost from sales.

Very simple; isn’t it? Any other thing apart from the formula you see above is not a financial statement. You might probably be expecting to see something that fills up the entire line but it is actually very easy. You should expect see sales at the first half of the document while costs are represented in the later half. You will find subtotals in the document down the column. Every value or result you see is obtained using the simple formula above.

Sometimes the difficulty comes in the use of different words to represent profit, costs and sales. For instance, instead of sales, you may see income or revenue; costs may be replaced by expenses or expenditure and profit may be called gain or net income. Perhaps, it is the way these words are used inconsistently that makes accounting somewhat confusing. Don’t worry; sooner or later you will get a hold of them, after all, a lizard will always be a lizard, no matter the name you call it.

There are different sources of sales, thus you can break the sales you realize from your business into several sources. For instance, if your run a fashion design company, your sales may come from renting out clothes, selling from your outfits and sewing for individual customers which is more common. These three sources will make up the sales record of your company. The sales from each of them will add up to the total sales of the business. The same also applies to cost. The cost of running your company may comprise of payment for labor, raw materials, building, machinery, and overhead. All these components will be broken out separately added to give the total cost which appears at the bottom end below all the expenses made by the company. Mind you, the word “expenses” is no different from costs; just a little swapping to make you grab the concept better.

In order to make more sense, costs are divided into direct and indirect costs. Direct costs are those costs incurred directly from delivering your services or products while indirect costs are those associated with other expenses arising from daily operations of the business. Using the fashion design company as an example again; the cost of the clothing materials used for making various cloth designs, the cost of labor and that of the machines and equipment all make up the cost of goods(clothes) sold because they can be directly linked with the complete designed clothes. Cost of service is associated with business that offer some sort of services. Both cost are abbreviated as COG and COS respectively.

When the value of sales is subtracted from cost of goods or service, gross profit or gain is obtained. In simple terms, this is the money you get after you minus the cost of delivering service or goods from the total money you make. It is from this gross profit that you pay for your bills and other cost incurred from the daily operations of the business.

Other costs that are not directly linked to the production of your fashion design wares may include payment to security operatives, accountants and marketers. All these cost will then be subtracted from the gross profit to give the net profit. This is how a profit and loss statement is usually presented. Take time and go throw the document again if you find anything confusing. A basic understanding of your business financial statements will enable you run your business more successfully.