Financials: What They Are and How to Use Them

Oct 23, 2009

Gaining financial control of a business involves several steps. But the first and most vital step in the sequence is tracking and recording all income and expenses.

To allow sales or other revenues to not be accounted for and to pay out expenses without any kind of paper trail is foolish. Therefore, a rod shop or speed shop, like any other business, should be accurately accounting its income and expenses.

By carefully tracking and recording all these things, a manager can review and examine the data with confidence, knowing that it truly reflects the financial state of affairs of the company.

Then the owner can make informed decisions.

Financial reports, or “financials” as they are sometimes referred to, are reports that show how a business activity has done from a monetary standpoint.

There are many types of financials that can be generated depending upon what it is you are trying to measure. Some are more complex and sophisticated than others, but the ones most useful to a small business operator are profit and loss statements and balance sheets.

Profit & Loss Statements: What You Made & Spent

A profit and loss statement itemizes by category all your income and expense sources.

Many common accounting software programs such as QuickBooks will generate a profit and loss statement for you.

Another program sets up “accounts” where by various expenditures can be coded and categorized.

For example, you might set up an account for “Office Supplies” where all expenses paid out by the company for these types of items would be grouped together.

At a later date you would be able to calculate how much you spent for this for any given period of time, as well as be able to look specifically into this “account” to see what you purchased.

I have reviewed financials for many retail businesses over the years.

Unfortunately, in some cases they have been so poorly constructed that they were virtually useless.

Accountants and bookkeepers often become immersed in the detailed actions of their trades without ever asking themselves how the information they are presenting will be of use.

Consequently there are some common mistakes that can easily be avoided.

The first of these is to have too few categories.

When you don’t break out your expenditures into specific categories (and subcategories) you don’t get a clear view of what actually happened.

For example, to have a stand-alone category of “Advertising” in your expense list may be inadequate.

Let’s say you placed a Yellow Pages ad, did direct mail and attended car shows to advertise your shop.

You will need to know how much you spent on each medium when comparing it to how much money you made with each type of advertising.

Always err on the side of having too many expense groupings rather than too few.

It makes for a little more bookkeeping but is certainly worth it when it comes time to do a financial analysis of your business. You can always trim back in the future if you find you’ve become overly detailed.

Another common mistake is filing distinctly different expense items into the same category.

For example, cost of goods and shop supplies should be two separate entries.

Cost of goods relates to the product you buy from your vendors; you want this to stand on its own.

You need to know exactly what you spent and what you spent it on so that you will be able to accurately calculate your gross profit on your goods.

Shop supplies are things the mechanics use to do installations or build things with; it’s completely different. To mix them together will obscure your ability to analyze each separate area accurately.

The first section in a “Profit and Loss” statement is the income section. This is where you will list where all your income came from. It’s important to break things out sufficiently so you can see where your sales came from and how much of it was labor.

The second section is the “Cost of Goods Sold” section, which is where you would show your purchases. You can also include some other subcategories here like freight or returns.

Additionally, a well-constructed profit and loss statement will also show beginning and ending inventory amounts in this section.

The third section is the “Operating Expenses” section. This is where you list out all of the other business expenses that are normally incurred in the day-to-day operation of a business. There will be many of these so don’t be afraid to list them all.

At the bottom will be the “Net Profit/Loss.” This shows if you made a profit or a loss for the period.

For a more informative profit and loss statement, create columns that show different comparative time periods.

For example, the first column could be for the past month, the second column could show the year-to-date totals, the third column would show last year’s same month and the fourth column would show last year’s year-to-date totals.

With all that data arrayed on a single page you can see not only how you did last month but also how that compared to the same month the year prior, as well as showing you your comparative year-to-date totals.

Another good thing to do is to show each category’s percentage of total income.

For example, if your rent expenses were 4.2 percent of your total income, this exact percentage would be placed next to that category.

This becomes particularly useful over time once you have learned what the poor, acceptable and good ranges are for the different expense category percentages.

The Balance Sheet: What Works and What Doesn’t

A balance sheet lists out all of the assets and liabilities that the business has. It normally is included with any profit and loss statement.

While the profit and loss statement shows the operational income and expenses that occur over a finite period of time, the balance sheet tends to reflect the longer-term financial picture and overall company value.

In the accounting world, various ratios and formulas are computed off of the balance sheet. While this is not significant to the business owner in his day-to-day running of the store or shop, it does become important when you deal with banks, lending institutions and appraisers. Therefore, some attention should be given to reviewing the balance sheet.

The main thing to look at on the balance sheet is the degree of debt that the company has (both short- and long-term), and whether this is increasing too much or too rapidly. Too much debt in relation to your income endangers your business and will classify you as “risky” as far as banks are concerned. The first section is titled “Current Assets,” which consists of cash or items that can be readily converted to cash in the normal course of business within a year’s time.

The second section is titled “Fixed Assets,” tangible properties used in the operation of a business but not expected to be consumed or converted into cash in the normal operations of a business.

The next section is titled “Current Liabilities,” debts or other obligations coming due within one year.

The next section is titled “Long-Term Liabilities,” debts that come due longer than one year’s worth of time.

Lastly, you should have a section titled “Equity.” This theoretically tells you how much inherent value exists when you measure the assets against the liabilities.

Smart Management

It requires many different ingredients to successfully run a business.

Part of that equation is a store that is financially solvent and viable.

That is primarily management’s responsibility and, in order to do that well, a manager must have accurate detailed information that he is familiar with and understands.

In this arena, the tools he must have are well-organized and informative financials that give a clear and true picture of the financial health of his business.