Accounting for Business: Understanding the basics for your financial health

PARTNER: ACCA

Business skills are discussed and evaluated often, especially when getting ready to launch or grow. Much time is spent assessing social media or branding skills, but not many are turning their sights to financial health.  

Are you skilled in evaluating the financial health of your business?

As a business owner, it’s essential to know how your business is performing financially, so you’re able to make decisions that may affect how fast your business grows or whether it’s time to outsource. It is even more significant if you have plans to seek investment or launch a crowdfunding campaign. Investors are keen to understand the financial health of your business, so you need to be as fluent as possible.

ACCA has excellent courses specifically designed to enable you to upskill and better understand your money. How to go about building a strong business, that is financially sound from the start.

Here’s a quick look into the three essential types of analysis you can carry out to achieve a greater understanding of your business’s financial health.

The cash flow statement

It’s easy to confuse the cash flow statement with the income statement. However, the two are very different for one crucial reason: the cash flow statement shows how much money a business has generated, disregarding any non-cash revenues or expenses. By having access to this information, you can understand what you have at the bank, whilst providing any proposed investors with a more precise and stronger view of your business.

Some of what the cash flow statement will allow you to analyse:

• The income sources within your business (cash)

• Any free cash flow that you can invest back into your business (outsource tasks)

• The increase or decrease in cash 

• The liquidation position of your business  

Knowing how to assess your cash flow statement is vital to understand your finances truly. It breaks down how you make money and where you spend it during a specific period –. In contrast, the income statement and balance sheet are based on accrual accounting (when a transaction occurs rather than when payment is received or made).

The balance sheet

Also known as the ‘statement of financial position’, the balance sheet will give you a clear overview of your assets, liabilities, and owners’ equity (net worth). This, combined with your cash flow statement and income statement, makes the base of your financial statements.

The formula for your balance sheet: Assets = Liabilities + Owners Equity 

Looking at this formula, we understand that the balance sheet is a balance of two halves. One half being the assets within your business and the other, a combination of your liabilities and the money you’ve put into your company (owners’ equity). These two halves will always equal each other out, thus showing that the assets used to operate your business are balanced by your liabilities and the money you put into your business as the owner.

A balance sheet will display your assets and liabilities as current assets or non-current assets. These terms will indicate whether an asset or liability is short-term or long-term.

Let’s explore these assets:

Current Assets

These assets will last a duration of one year or less and can be converted into cash reasonably quickly – assets such as a product or service sold on credit, which will need to be paid within 12 months. Other assets of similar nature could be goods available for immediate sale, also known as your inventory (these may be raw materials or products purchased from a wholesaler or manufacturer), money in non-restricted bank accounts, or cheques. 

Non-Current Assets

Non-current assets are the opposite of current assets, so they cannot be converted into cash as quickly and are expected to have a delay spanning from within 12 months or more. These assets can be tangible and may vary from laptops, buildings, land to vehicles, or office supplies. Non-current assets can also be intangible, which may include patents or copyright. Although intangible assets are not physical, they form an essential part of any business and if not present can cause severe damage. Take, for instance, the patent behind a technical product, giving the owner or business complete control and ownership of the design – which stops others from using their invention. Should they lose this patent, it will completely break the company and its position in the market. Now, anyone can design and sell their product – devaluing the concept and power to secure financial support from investors as well as the value behind their brand name. 

Going back to the balance sheet, both assets and liabilities will be inputted as current or non-current, showing whether they are short-term or long-term. You will be able to see the short-term assets that are due to turn into cash within 12 months and the long-term assets that are not due within a year. On the other hand, short-term liabilities are expected to be paid within 12 months, and long-term liabilities are not expected to be paid within 12 months.

Some of what the balance sheet will allow you to analyse: 

• The expected period to receive payments as well as when to pay your bills

• How long it typically takes to sell your products (inventory)

• Short-term liquidation (less than 12months)

• What portion of your assets are tangible/intangible

The Income Statement

The income statement or the ‘profit and loss statement’ is one of the three most important financial statements used to determine the financial health/position of a business – with the other two being the cash flow statement and the balance sheet. 

It allows you to pinpoint the performance of your business at any period, whilst looking at your expenses, sales, and profits. 

The formula for your income statement: Net Income = Revenue – Expenses

(Net Income = Revenue + Non-Operating Items) – Costs of Goods Sold + Operating Expenses)

Whilst the balance sheet provides information from a specific date; the income statement provides information from a particular period of time. It begins by calculating the revenue, deduct the cost of producing the products sold, to conclude the gross profit for the period you’ve selected. It will then work to minus all other business expenses, such as rent, energy bills, salary, and any non-cash expenses (such as depreciation) that may have occurred. Lastly, it takes away any interest and tax paid to conclude the net profit. The net profit can then be reinvested into areas to continue the growth of your business. 

Some of what the income statement will allow you to analyse:

• Net profit after deducting all expenses

• How much revenue has been made across a specific period

• What is paid to the owner and what is reinvested back into the business 

As a business owner, it’s vital to be not only aware of but also be able to assess the financial position of your business. This is particularly important if you have plans to seek investment or discuss growth plans with your staff or specifically your sales team.  

Ready to learn more and develop a full understanding of your finances? Discover courses from ACCA that are geared towards empowering you whilst giving you the skills you need to understand your money and make better financial decisions, future-proofing your business.