If you are relatively new to the business arena, you’re probably not too good at reading financial statements. But for someone who is planning to start a small business, it is crucial to learn how to read financial statements and understand what they mean.

Today, we are going to discuss one type of financial statement called the profit and loss statement. A profit and loss statement is a summary of your income and expenses over a certain period of time, usually a quarter or a year. The profit and loss statement is important because it helps you to understand the profitability or financial condition of your company over that certain period of time.

The main components of a profit and loss statement are:

Sales – Constitute the total revenue received from the sale of a good.

Cost of goods sold – These are the costs directly linked to the production of the good.

Gross Profit (Loss) – Results when the cost of goods sold is subtracted from sales revenue. The gross profit represents the profitability that is generated by the sales revenue.

Operating expenses – These are the general and administrative expenses that are incurred in the day-to-day running of your business; some examples are employee salaries, advertising costs, and rent.

Operating Profit – Results when all the operating expenses are subtracted from the gross profit. The operating profit represents the profitability that is generated when the daily operating activities of the business are taken into account.

Other income and expenses – These are earnings or expenses that a business would not normally have in its day-to-day operations. A good example could be rent earned from a property or interest that is paid on long-term debt. The expenses are subtracted from the earnings in this component to arrive at a net figure.

Net profit before taxes – Results when the net figure for other income and expenses is either added or subtracted from the operating profit. Net profit shows how profitable the company is after all the different types of expenses have been deducted, that is, before it pays it’s taxes.

Income taxes – This is the amount of taxes the company is obliged to pay.

Net income (loss) – Results when the income taxes have been subtracted from net profit. If the net income is positive, the company has been profitable over the accounting period. This figure represents the overall profitability of the company when every single cost of the business has been accounted for.

The net income is essentially the bottom line and constitutes the amount of money that the company has left at the end of the period.

As a business owner, you should be able to understand how profitable your company is. From the profit and loss statement, you can easily identify which types of costs took the most away from your bottom line and start thinking of ways that you can curb them.

The profitability of your company will also be of interest to banks and lenders. A profitable company shows that it is adept at making the most out of borrowed funds and will have less of a problem securing funds in the future. Now that you see how useful it can be to develop your understanding of this type of financial statement, it would definitely be a good idea to do some additional reading up on the subject.

To get a bigger picture of how some of the components of a profit and loss statement can be used in a budget, have a look at my article called “How to Prepare a Budget”.

If you want to do well as a small business owner, it would help you if you could understand the basics of how to read a balance sheet. The balance sheet is an indispensable part of a business accounting information and is essentially a snapshot of a company at a specific point in time.

The balance sheet lets you know what a company owns (“assets”) and what it owes (“liabilities”). It will also tell you how much the business is worth.

The company’s assets can normally be divided into current assets and non-current assets. Current assets have a high liquidity value and can be turned into cash quickly. Some examples of current assets which are stated in a balance sheet are cash, accounts receivable (also called debtors), and inventory.

Non-current assets, on the other hand, cannot be easily converted into cash. Some examples of non-current assets are machinery, buildings, or real estate.

The company’s liabilities can also be divided into current and long-term liabilities. Current liabilities are debts that the company must pay back in less than a year. Some examples are accounts payable and 12 months of interest payments on longer-term loans. Long-term liabilities are debts that are due after a minimum of one year.

Shareholder’s equity is made up of the money that was invested into the business at its start and retained earnings. Retained earnings are profits that are not paid out to the company’s owners but are re-invested into the company. Shareholder’s equity is the company’s net worth.

So now that you understand the basic components of the balance sheet, let’s take a look at what types of analysis can be generated from it.

The information in a balance sheet is used to generate many different types of financial ratios. Though we will not get into the mechanics of these ratios in this article, it is important that you understand that they are used to gain insight into many diverse aspects of the business.

Debt-to-equity ratios, for example, will show how extensively the company relies on debt to finance its growth. Financial strength ratios will tell you how good the company is at repaying its debts.

In conclusion, the balance sheet’s purpose is to let you know the business’ financial health and liquidity at a selected point in time.

Investors and lenders prefer that the current assets of a company are higher than the current liabilities because it means the company will remain solvent in the immediate term. Cash shortages are then unlikely and the company will not have to rely on additional funding to meet its obligations.

If you dig a little deeper into the types of analysis that can be done with balance sheet items, you just might be fascinated. With a little basic knowledge, you’ll impress you bank manager and even your accountant!

If you are interested in learning more about how to measure the health of a company, read my article called the “Top 5 Warning Signs that your Business is Declining”.

Cash flow provides the necessary fuel to propel your small business forward. Cash flow problems can lead to an insolvent business structure and are a leading indicator of a failing business.

Here are 7 of the most common causes of cash flow problems in small business and solutions to help you avoid them:

1. Lack of Payment Term Discounts
Waiting for a customer to pay once you have delivered a product or completed a service can cost your business valuable money. Offer your customers a term discount such as 2% net 10, or 1% net 5 in order to encourage them to make their payments quicker to receive a discount.

2. Lack of Tracking
Tracking your business results is crucial to its overall success. Install tracking systems in the areas of your business where you can improve cash flow such as inventory management, supply ordering and procurement to reduce waste and improve turn around times.

3. Failure to Perform New Client Credit Checks
Ensure that your new clients have credit checks before your business ships out product to avoid an untimely payment or a payment default from a business with a poor credit history.

4. Lack of Credit Insurance
Failure to have credit insurance, especially when working with customers internationally, can cause the business to lose substantial cash flow if the customer is slow to pay or defaults. International customers are also more challenging to take financial action against. To learn more about how to handle bad business debts, read my article called 5 Ways to Handle Bad Debts.

5. Slow Product or Service Turnaround Times
Shorten the delivery times of your products or services to your customers to maximise the level of potential profit.

6. Taking Cash Instead of Credit
Change your business structure to where your only methods of payment are credit cards or online banking systems to decrease the wait time for business payments by check.

7. Failure to Leverage Factoring or Inventory Financing
Failure to leverage these financing solutions when your business is producing or manufacturing a product or service for a client, can cause the business to suffer a short term cash flow problem. Consider leveraging factoring for the customer’s order or inventory financing for the required purchase of inventory to product their product or service to help your company’s short term cash flow problem.

Learning from these 7 common cash flow mistakes and applying the relevant solutions will help your business to improve cash flow and avoid potential insolvency. For more information on how to improve your cash flow, read my article called Proven Tips to Improve your Cash Flow.

Your company’s vision statement is the statement of its potential and of what you want your business to become. Your vision statement should be meaningful to you and your organisation. It should be shared will all of the employees in your organisation in order to create a unified direction for everyone to move in.

Crafting a vision statement is a challenge for many business owners, so I have included several strategies in this article for you to make this process easier to complete.

Begin by describing the best possible business future for your company, using a target of 5-10 years in the future. Your written goals should be dreams, but they should be achievable dreams. Unachievable goals can create frustration for all parties involved and can cause a decrease in your organisation’s morale.

When writing your vision statement, use the present tense, speaking as if your business has already become what you are describing. Use descriptive statements describing what the business looks like, feels like, using words that describe all of a person’s senses.

Your words will be a clear written motivation for where your business organisation is headed. Your words can be as long as you would like them to be, but a shorter vision statement may be easier to remember.

Ask yourself the following questions as you craft your vision statement:
• What do you want your organisation to look like in the future?
• What is your organisation currently excelling at? How is your organisation currently competing in the market place?
• What do you currently use to judge your organisation’s effectiveness?
• What do your employees see for the company’s future? Ask for their advice.
• Visualise the end result of where you would like your business to be. Visualisation will help you choose the words to craft your vision statement.

Once you have completed your draft vision statement, summarise your thoughts into a single, powerful phrase to describe your entire vision statement. Your employees will remember this powerful single statement, and it will become a motivation tool within your organisation.

Share your vision statement with everyone that supports you and your entire organisation. It can take some time for the vision statement to become a common practice, but if regularly discussed and reviewed, your vision statement will become a part of your organisation’s culture.

Are you tired of working constantly without a vacation and having the money to show for your efforts? If you are wondering whether you are in the right business, consider the following questions:

Do you know the ins and outs of your business?
Understanding the ins and outs of your business and the industry that your business is in is a crucial component that will determine whether you will be successful. Are you aware of the key metrics for your business success?

If not, take a moment and complete a SWOT analysis. SWOT stands for strengths, weaknesses, opportunities and threats. Draw a T-chart on a blank sheet of paper and diagnose your current business successes and failures.

If there is not enough opportunity and too many threats and weaknesses, you are potentially in the wrong business. If there are strengths and opportunities, revise your business plan to cater to these listed items.

Do you have a solid business plan?
Developing and executing a solid business plan is a crucial step toward ensuring that your business will become successful. Include accurate cash flow projects and forecasts for your expected profit so that you can review this information and make informed decisions about what your next business steps will be.

Are you spending time on non crucial tasks?
Choosing the core tasks to focus your energy on can be challenging. Many small business owners spend most of their time putting out fires and working in the business instead of strategically working on their businesses. Define the core tasks in your business that drive its bottom line and structure your schedule so that these tasks are dedicated the most time and that they receive daily priority.

For more information on how to leverage your time, read my article called Leverage your Time and Use it More Effectively.

Do you know the business that you are in and have passion for it?
Lack of passion will almost surely cause business failure. Ensure that the business you are working on is something that you are familiar with and that you can fully get behind, as it is passion that will provide the needed energy to fuel the business toward success.

When you are familiar with a particular industry or field, the training that you have received, the knowledge of the industry and the network that you have built will better enable you and your business to achieve success.

Choosing the right business to invest your time into can be challenging and if you are currently a small business owner who is not seeing the levels of success that you desire, as yourself these questions to reposition yourself for a higher chance of success moving forward.

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Setting goals personally and professionally is a crucial step to implement to ensure success. Here are 10 Commandments of Goal Setting:

1. Be Passionate

Be passionate about your goals so that you are motivated to achieve them. Scratch off any goals on your list that you are not willing to do anything it takes to accomplish them.

2. Be Realistic

When you choose goals for yourself, it is okay to dream, but you want to be as realistic as possible. You do not want to become discouraged when you don’t achieve a specific goal. Choose time frames that are reasonable and goals that are a stretch from where you are today.

3. Write your goals down

Writing your goals down will lead to an increased chance of achieving them. Write them all down and then prioritise them in order of personal importance.

4. Be Detailed

Every goal should have a time frame and amount assigned to them. For example, “I would like to increase sales by 10% by the end of the year”; instead of, “I would like to increase sales for my business”.

5. Be Accountable

To become successful at achieving your goals, you will need to hold yourself accountable by scheduling regular check points for progress review.

6. Ask for Help

Mentors and other professionals are valuable tools to help you in achieving your goals.

7. Have Integrity

Do what you say that you are going to do.

8. Be Persistent

Keep going until you reach your goals. Don’t give up prematurely.

9. Be Prepared for Failure

If you fail, set a new goal and keep going. Most successful people fail at some point, and most business owners will tell you that they have failed numerous times on the way to becoming successful.

10. Reward Yourself

Choose a reward for each goal that will encourage you to work hard to achieve them. You are more likely to work hard when there is a reward at the end of the process.

To apply goal setting to your business, read my article called, “5 Reasons why a Business Plan is Essential for your Business”.