Cfo Services | Why Entrepreneurs Should Understand Profit And Loss Statements
Understanding business finances should be a huge priority for entrepreneurs says CFO services. Understanding the overall financial health of their business can help entrepreneurs guide their business. By understanding how to minimize their expenses, and how to maximize profits, can help business owners avoid cash flow issues in their business in a proactive way. By understanding where their business finances are throughout the year, can help business owners make decisions that can affect their business, that can help them avoid running out of money in their business. It can also help entrepreneurs know when is the right time to make asset purchases in their business, and when they can hire staff or if they need to lay staff off.
CFO services says that entrepreneurs should understand that when they’re looking at their interim statements, there is a reasonable chance that those statements will have some errors in them simply because they are not being as strictly checked as year-end statements are. Therefore a business owner should look at their balance sheet before they look at their income statement. This can help them see obvious errors that might exist on their income statement, that they will only see if they were previously looking at their balance sheet first.
The next thing that business owners should take into consideration when they’re reviewing their profit and loss statement, is that they should be looking at statements that are six months at a time. CFO services says that this way can help business owners see trends in their business. Are they becoming more profitable, are they becoming less profitable, is there an error somewhere, or is the business is seasonal, and more likely to have huge sales in one or two months. By understanding these things about their business, an entrepreneur can have a much more effective review of their financials.
The next important thing that business owner should take into consideration is looking at their income statement. Income statements should be organized in numerically descending order with the most expensive costs at the top of the page, and the least expensive at the bottom. The reason this is important says CFO services, is that a business owner will be able to see at a glance what the most significant expenses in their business are. If they would like to make changes in their business to become more profitable, or at least reduce expenses, they know that they will be able to affect great change in a short amount of time by working on the top half of their income statement.
It’s also very important that business owners understand that the impact of this income statement is in its simplicity. CFO services says that many business owners feel like they want to include as much information as possible in this report, but that’s actually counter productive because the more information and more subcategories in this report, the harder it is to read. By having simple categories of expenses, business owners will be able to easily use the income statement is a powerful decision-making tool.
Even though many entrepreneurs get into business for themselves, because they have a passion to deliver the product or service that their business is known for, and not because they are experienced at running businesses says CFO services. Because of that, business owners often find that they are challenged in being able to effectively run their business. Entrepreneurs who don’t understand how to read profit and loss statements, tend to make financial decisions that don’t greatly benefit their business. 50% of all businesses close their business within five years, and 29% of those entrepreneurs say that running out of cash was the reason their business failed. Helping business owners understand financial statements, can go a long way in helping them make better financial decisions, and avoid running out of money.
One of the first things that business owners should take into account when they are looking at their finances, is that their salary should be separate from all other expenses. CFO services says that this may seem wrong to most entrepreneurs, because since they are working in the business, their salary should be a business expense, but this is not true. A business owner needs to be able to determine the success of their business without utilizing their salary. Business owner should be able to determine how successful the business is with out putting that salary into the equation. Since ultimately, the salary that a business owner pulls out of the business is essentially a tax strategy it is not appropriate to have on their business expenses.
Since most business owners will get loans at some point in their life, understanding how those loans look in their income statement is very important says CFO services. Asset purchases do not belong on the profit and loss statement says CFO services. The reason for this is because when a business buys an asset, it will amortize in the business for the useful life of that assets. It needs to be reflected that way in balance sheets, otherwise purchasing an asset will give the month it was purchased in a huge negative hit, that may not be accurately reflected in the health of that month.
the principal portion of a business owners loan should not appear on their income statement says CFO services. Although the principal will appear on the business owner’s balance sheet, and that amount should produce over time as the entrepreneur based on that loan. However, a business owner also needs to be aware that the interest will appear on their profit and loss statements. Because of these, business owners need to be aware that despite the fact that there loan payments does not appear on their income statement, they still need to pay the principal and the interest of their loan.
By understanding how to read the profit and loss statements, business owners can be a lot more prepared to make financial decisions that make sense to their business including how to increase profits and cut expenses.