At the end of 2020 I was asked by a fabulous local Virtual Assistant a few questions for her "Ask the Expert" feature. Here's what I had to say....
Q - If I wanted to review the overall health of my company, which financial statement would I use, and why?
As business owners it’s important to know the key measures that are important in our own businesses. Even looking at a bank balance can be unrepresentative depending on the day in the month.
The profit and loss statement, aka. the income statement, shows the financial performance of the business – the income earned and the costs spent to generate it – its profitability.
The balance sheet shows the value of the business – made up of the assets owned or are owed to the business against the liabilities owed to others. As a minimum, we want this to have a positive value, although in some businesses that can take time to achieve.
The best determinates to a business’s health is to identify the key performance indicators (KPIs) specific to that business and monitor these on an ongoing basis. For example, these might be, the cash balance, sales revenue/turnover, sales conversion; but all of these need a context to understand if they are good or bad.
Q - What is working capital?
Working capital is the way we fund our business and the business’s ability to generate the money to sustain itself.
Flashback to a maths lesson ......
Working Capital = Current Assets - Current Liabilities
In short, we need money coming into the business to fund the money going out of the business.
The money coming in can be cash, well more likely, bank transfer and card payments these days; but worth considering how quickly people pay the business’s invoices. The average days between raising the invoices and receiving payment are the debtor days. For money going out, the average days the business takes to pay its suppliers are the creditor days.
If debtor days are more than creditor days, then there is a funding gap. This means that the business is paying money out quicker than it is getting it in and therefore the owners/shareholders must be funding the business personally or with longer term debt, in order to just pay the normal costs.
The management of working capital is fundamental for business survival and growth. Consideration of payment terms is one aspect of this, always ensure a business’s invoices include payment terms and a due date.
Q - Can you explain what making tax digital really means to the small business owner?
Making Tax Digital (MTD) is coming and there are various stated reasons for it to be bought in.
- For small business owners, it means that they need to get organised and keep on top of their financial information.
- Embracing technology is essential, and to get the value from that technology, it is worth utilising not just for the minimal requirement levels but to utilise it fully to help understand the business better and work more efficiently as a result.
- If reviewing business financials is an annual process, it will need to become a quarterly, potentially monthly, process. Keeping things up to date is always much easier than gathering it all together once a year, but this is likely to become vital to enable MTD reporting.
Q - What is a bank reconciliation and why is it so important to do at the end of each month?
A bank reconciliation is simply reviewing through the transactions that appear on the bank statement and checking them back against all the accounting entries in that period.
If the business is using software then completing a bank reconciliation can be a very simple process. Another great reason to embrace technology!
By completing a bank reconciliation the business ensures that:
- The financials are up to date;
- It is aware of how money is being spent;
- It is aware of who owes the business money;
- It is aware who the business owes money to; and
- There is an ability to catch any fraudulent transactions quickly.
This means that on a regular basis there is consideration and review of all banking activity. And it doesn’t have to be monthly, you could work through it more frequently than that, doing a little and often to help make it manageable.
Q - Can you recommend a basic free accountancy package that would be an ideal start to a business owner who has previously used spreadsheets for accountancy recording?
Sorry I can’t! Mainly because I consider that it is worth paying for accountancy software. If you want a software that is keeping up to date and being supported then I would always point towards a paid for software.
For me, I love Xero. There are often several ways to do things within the system so users can find the way that works for them and it has a great support function if you cannot work it out yourself. The integration it offers with lots of varied apps is brilliant too.
If any of the above questions have made you want to think about these further and get dome support around them, then we'd love for you to get in touch and we can see how we can help you. Whether it is helping to determine and set-up monitoring for KPI's, helping you understand your financial statements and knowing where the value lurks, improving efficiency through your record-keeping, setting up on software or some training on it, we'd love to catch up and understand your business better and see if we can support you.