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Understanding your finances

Bridget Holmstrom - Tuesday, September 16, 2014

BH Financial Tuition is holding an Introduction to Finance session, 9am to 1pm, Thursday 25th September 2014

The Wilton Centre, Wilton, Redcar, TS10 4RF

What do financial statements tell you?

We all make assumptions every day.  Assumptions allow us to make decisions and fill in the gaps in our knowledge.  The problem is that we believe that our assumptions equal knowledge and this is clearly not the case.  When a possible prospect fails to ring us back we assume that they have decided not to use our services.  Really?  Or perhaps they have gone on holiday, just had a baby, undergoing an HMRC investigation, going through a major IT project or frankly we are not top of the list of things to do today.  The reality is that until we find out the truth we are just guessing. 

The same is true in our business finances.  Managers make assumptions about all sorts of things.  This employee is the most productive, or that supplier is the cheapest and provides the best value for money, or even worse the customers are happy because they haven’t called to complain.

Learning to read and understand your profit and loss, balance sheet and cashflow will help you to read and really understand the business and stop filling in the gaps in your knowledge by making assumptions. 

  • Profit and loss will tell you where you are making your money and where you are losing your money.  It will help you to identify where the unexpected is happening.  But remember you have to benchmark your profit and loss against something whether that is budget or last year’s results.  If you don’t compare then you won’t know whether the situation is improving or worsening.
  • The balance sheet will tell you whether your sales are converting properly into cash or languishing in trade debtors.  It will help you consider whether or not you should improve your credit control process.  The balance sheet will also show you how much the company owns in fixed assets such as IT, cars, buildings and equipment.  It will also show how the company is being supported financially, long-term or short-term loans, by owner equity, or perhaps your suppliers are funding the business.
  • Last, but definitely not least, understanding cashflow is probably the most important part of the puzzle.   This is because cash will determine whether or not an organisation, large or small, can remain in business.  With sufficient cash reserves a business can survive, though not indefinitely, no matter what is thrown at it.  Even companies with healthy profits will go out of business if the cash runs out and they cannot pay their creditors.

The profit and loss, balance sheet and cashflow all tell the story of an organisation.  They show how circumstances are improving or worsening and whether the company is in good health or whether in need of some serious care and attention. 

Understanding financial reports give the manager the opportunity to find out the truth and stop making assumptions.