Owning and running a small business is very similar to being a professional juggler. In addition to business operations, there are a number of other critical areas of the business that must be juggled.
Learning to Juggle
As well as ensuring the business operations are functioning efficiently, business owners need to pay attention to areas such as sales and marketing, personnel management, research and development and financial management.
Juggling all these different areas requires business owners to become familiar with new terms and concepts. Many of these relate to managing the finances of the business and meeting tax and other regulatory obligations.
One of the hardest things for small business owners to understand is the critical importance of the financial side of their business for future success.
In reality, business owners often consider accounting reports, balance sheets and profit and loss statements as a necessary evil required to meet GST and tax obligations, rather than the important financial statements that they are.
Using a Scoreboard
Anyone who either watches or plays sport understands the importance of a scoreboard. Can you imagine playing or going to a game of rugby, Australian rules, soccer or cricket without a scoreboard?
In sporting terms, the profit and loss statement for a business is its scoreboard. It tells the owners whether they are winning the game of business (by producing a net profit) or losing (because they are incurring losses).
The main difference between a profit and loss statement and a sports scoreboard is simply that the former includes more detail that can cause confusion and overcomplicate the results shown.
One way of understanding how a profit and loss statement works is that in addition to showing whether a business is winning or losing, it also includes the additional information kept by coaches of a sporting team to look at where the team’s performance can be improved.
Income and Expenses
The first thing to consider when trying to understand how a profit and loss statement works is that it is made up of two main components: income and expenses. Income is further broken down into direct income, such as sales or fees generated, and indirect income, such as interest earned or the proceeds of business-asset sales.
Expenses are also further broken down into direct expenses, those that are directly linked to the generation of the income and sometimes called cost of sales, and indirect or overhead expenses.
Direct expenses are those that increase or decrease depending on the level of income being generated. For a manufacturer, direct expenses include materials and direct labour costs, while for a retailer it’s the net cost of stock purchases.
Overhead expenses are those that do not depend on the amount of revenue produced, but must be paid just because the business is operating. Overhead expenses include rent, interest on loans taken out to purchase the business, insurance and vehicle costs.
Tallying the Results
In the final analysis of your profit and loss statement, for your business to grow and prosper, you need to ensure you’re looking at the profit or loss scoreboard throughout the whole financial year – not months after it’s finished.
If you don’t measure something, you can’t improve it. The profit and loss statement for a business is the starting point for owners to properly measure the financial activity of their business, and find ways of improving its overall profitability.