Solving the riddle of your accounts

Your accounts can help you in terms of two measures:

– Is your business making enough sales to cover its costs and more, i.e. is it making a profit?

– Is it bringing in enough actual money to cover its bills, that is, is its cashflow healthy?

Here are five clues to look for in your accounts to gauge how your business is doing in terms of profit and cashflow.

Your profit and loss account is most useful when you look at this year’s figures and compare them to last year’s, or to your planned figures.

If you compare your business’s sales for this year to last year, you can tell whether your sales are going up or down, especially if you can do that comparison on an on-going basis for several years.

This can help you judge whether your business is growing as you hoped, or whether you need to possibly put up your prices, or look for more customers.

Let’s take an example. 

Alice is a self-employed web designer.  She looks at her profit and loss account for the years ended 5th April 2011 and 5th April 2010.

Her business made sales of £60,000 in the year to 5th April 2011, compared to £55,000 in the year ended 5th April 2010.

Alice is pleased that her sales income has grown, but realises that it doesn’t actually reflect the big increase in volume of sales she has achieved.  

She thinks that she may not be charging enough to some customers, because they are personal friends as well as business friends.

Are you, like Alice, being too nice to some of your customers and not charging them enough?  You can use tools such as FreeAgent’s project profitability graphic to help you see whether some projects are bringing in less sales and profit than others.

Checking your sales regularly is also a very useful measure if you think you might need to register for VAT.  Remember that each month you need to check your taxable sales and see if you’re going to go over the limit (which is £73,000 at the moment) for the past 12 months, or in the next 30 days.

When you compare this year’s profit and loss account to last year’s, you can also see which individual costs might have gone up this year compared to last year.

Which suppliers are stopping you making more profit?

Alice checks her individual cost lines.  She sees that suddenly she has a new line for bank charges.

Many banks will give free banking to new businesses for a couple of years, then stop – and some banks put in their account terms and conditions that their free banking will apply only to businesses who pay a certain amount into their bank accounts each month.  

As Alice has now had her business bank account for over 3 years, her free account period has expired.

She will need to expect bank charges to be part of her on-going costs and plan for this.

This is another reason why she will need to put up her sale prices.

It’s also very useful to work out what accountants call your business’s “profit margin”.

That just means taking your profit and dividing it by your sales.

You can also work out your “gross margin” or “gross profit margin” if your business has cost of sales.

Your business’s gross profit is its sales less its cost of sales – and the gross margin is its gross profit divided by its sales.

Alice’s business made sales of £60,000 in the year to 5th April 2011, gross profit of £50,000, and final profit of £40,000.  Margins are always given as a percentage so Alice’s business’s gross margin for that year was 83.3%, and final profit margin was 66.7%.

What information does the margin give you?

Like any other profit and loss measure, it’s most useful when you compare it to your margin for previous years.

Alice looks at her profit and loss account for the years to 5th April 2011 and 5th April 2010, and works out her margin.

It’s been going down steadily for the last couple of years, so this means that for every pound of sales Alice makes, she’s earning less profit, so getting to keep less of what she’s earned.

That’s not good news.  Alice investigates further.

She realises that, while her suppliers have put up their prices, she hasn’t, because she doesn’t want to upset her customers, some of whom are her friends (see Profit: Clue 1).

Also, one of Alice’s larger suppliers has registered for VAT, and because Alice isn’t registered, that’s effectively a price increase as far as she’s concerned.

Alice needs to consider either registering for VAT herself, or changing her supplier to a non-registered business.

She also needs, again, to consider putting up her prices.

Looking at your profit and loss account shows you how much profit your business has made, which can help you work out how much tax you’ll have to pay.  Tools such as FreeAgent’s tax calculation projections will give you an idea of this, whether your business is a limited company or any other type of business.

If you’re a sole trader or in partnership, you can then start putting money aside for your tax payment on 31st January 2012, and possibly also 31st July 2012.

It’s never too early to do this – you don’t want to be saving for your tax bill at the same time as saving for Christmas!

Alice looks at her balance sheet as at 5th April 2011.

She sees that its total figure is positive.  This is a good sign, as it means she should have enough to pay what her business owes.

But as a sole trader, she needs to remember that the tax on her business’s profit doesn’t show up as something her business owes – because that’s something she has to pay as an individual.  She needs to keep enough cash for her tax.

She also sees that, although her balance sheet total is positive, that is in a large measure because she has an expensive iMac.   Her business’s current assets – cash at the bank, and money her customers owe her – are actually lower than its current liabilities, debts due in the short term such as money she owes to her suppliers.

That means that, if all Alice’s suppliers suddenly asked her to pay everything she owes them, and the bank asked her to repay her business overdraft, she would have to sell her computer in order to do that, effectively putting herself out of business.

That’s not good news – and is yet another reason why Alice needs to put up her prices, so that her customers will pay her enough to cover her dues.

What if putting up my prices loses me customers?

Many business owners have that worry and consistently under
charge.

But when they come to put their prices up, they actually lose very few customers.  You need to judge how price sensitive your market is and what the market rate for the service you are providing is.

Are you like Alice?  Do you need to put your prices up to help your business succeed?  Check your accounts for tell-tale clues.