Financial statements help business owners understand profitability, financial position and cash flow. However, the figures can be misleading if they are read in isolation or confused with the amount of money available in the bank. Understanding three key financial statements can help you make better business decisions.
1. Understand what the balance sheet shows
The risk: Assuming that a healthy bank balance means the business is financially strong, without considering debts and other obligations.
What to do: Review the balance sheet, which shows the business’s assets, liabilities and equity at a particular date. Assets include cash, stock, equipment and amounts owed by customers. Liabilities include supplier balances, loans and outstanding taxes. Equity is the residual interest after deducting liabilities from assets.
For example, if a business has £10,000 in cash and £5,000 in stock, with £3,000 in outstanding loans, its net assets are £12,000, assuming there are no other assets or liabilities.
2. Understand the profit and loss account
The risk: Confusing sales with profit or assuming that all reported profit is available to spend.
What to do: Review the profit and loss account, which summarises income and expenses over a period. Revenue is income earned from sales or services; expenses are costs incurred in operating the business. Profit or loss is the difference, subject to the applicable accounting treatment.
For example, a business with £20,000 of revenue and £15,000 of expenses reports a profit of £5,000 for the period. This does not necessarily mean that £5,000 has been received in cash.
3. Understand the cash flow statement
The risk: Focusing on accounting profit while overlooking whether sufficient cash is available to pay suppliers, employees and tax liabilities.
What to do: A cash flow statement reports cash received and paid during a period. Cash movements are generally grouped into operating activities (day-to-day trading), investing activities (long-term assets) and financing activities (borrowing, repayments and capital transactions).
For example, if a business receives £10,000 from customers, spends £3,000 on equipment and repays £2,000 of borrowing, the net cash inflow is £5,000, assuming there are no other cash movements. Not every small business must prepare a formal cash flow statement; a cash-flow forecast can still help manage day-to-day finances.
4. Understand why profit and cash are different
The risk: Making spending decisions based on reported profits without considering unpaid invoices, stock purchases or upcoming liabilities.
What to do: Compare profit with actual cash movements and outstanding balances. A business may report profit on invoices customers have not yet paid. Equally, buying equipment may reduce cash immediately without the full cost appearing as an expense in the same period. Review customer debts, supplier payments, tax liabilities and cash alongside profit.
5. Compare financial results over time
The risk: Looking at one set of figures without understanding whether the business is improving or facing increasing financial pressure.
What to do: Compare current results with previous periods, budgets and forecasts. Consider sales, gross profit margins, operating expenses, customer and supplier balances, borrowing and available cash. Investigate significant differences rather than assuming higher turnover means better performance.
6. Use financial statements to support decisions
The risk: Preparing accounts only to meet filing or tax obligations, without using the information to manage the business.
What to do: Review the figures when considering pricing, borrowing, investment, staffing and future expenditure. A monthly or quarterly review can help identify falling margins, rising overheads or cash-flow problems. Financial statements report historical information; budgets and forecasts help assess what may happen next.
How Johnson Accountants can help
Johnson Accountants can help small businesses understand their financial statements, review profitability and cash flow, and interpret accounting information when making business decisions. We can also assist with bookkeeping, annual accounts, management information and relevant tax obligations.
For further guidance on managing business finances, read our Cash Flow Management guide and explore our accountancy and tax services
If you would like help understanding your business accounts, you can book a meeting with Johnson Accountants.
This article provides general information for UK small businesses and is not a substitute for advice tailored to your circumstances.
