You don’t have to be a CPA to understand which numbers are most critical to the health of your business. Having a strong relationship with your accountant is a must for any business owner – however, as a business owner the financial health of your business is ultimately your responsibility.
The most critical numbers of your business can be found on three very important documents a balance sheet, income statement and cash flow statement. Below is a quick review of these basic financial documents that track the flow of money within your company.
A statement of the assets, liabilities and capital of a business at a particular point in time. This is a cumulative document from the time you started your business, reviewing your balance sheet will give you a good perspective on the financial strength and capabilities of your business.
This document otherwise known as a profit and loss statement or P & L, lists your company’s income minus your company’s expenses during a specific period of time-usually a fiscal quarter or year. These records provide information that shows the ability of a company to generate profit by increasing revenue and reducing costs.
Cash Flow Statement
This document will help you understand why, even if your company appears to be turning a profit, you still don’t have much money in the bank. A cash flow statement shows the amount of cash generated and used by a company in a given period. It is calculated by adding non-cash charges to net income after taxes. Cash flow can be attributed to a specific project, or to a business as a whole. A Cash flow statement can be used as an indication of a company’s financial strength.
Now that we have a basic understanding of the three important financial documents and how they track the critical numbers for your business, let’s move on to profits and understanding critical profit numbers. There are three important and basic terms that represent the profitability of your business, gross margin, net income, and EBITDA (earnings before interest, taxes, depreciation and amortization).
Gross margin or profit is your company’s total sales revenue minus its cost of goods sold and divided by the total sales revenue and expressed as a percentage. In other words, the gross margin represents the percentage of total sales revenue that your company retains after incurring the direct costs associated with producing the goods and services sold. The higher the margin, the more the company retains on each dollar of sales to service its other cost and obligations such as salaries, rent, advertising, telephone and utilities and still make money.
Your Company’s net income or bottom line is an important measure of how profitable your company is over a period of time. The net income is calculated by taking revenues and adjusting for the cost of doing business, depreciation, interest, taxes and other expenses. This number is critical because it reveals how much money is left in your business after all the expenses are taken out, if the number is negative your company is not profitable and has in effect produced a loss.
Earnings before interest, taxes, depreciation and amortization is often used to make profits look better in comparison to net income. Although EBITDA is widely used as a way to report earnings for a company it can be deceptively optimistic because it doesn’t take into the expenses of taxes and interest payments. EBITDA is best used to provide a cleaner view of a company’s core profitability, the higher the EBITDA margin, the less operating expenses eat into a company’s bottom line leading to a more profitable operation.
Tracking your business profits should be self- explanatory, however there are several terms that represent the profitability of your business which can make things confusing. Understanding the three terms and definitions above should give you a better grasp on how to track your company’s critical profit numbers.