5 things you didn’t know about your statutory accounts11 Oct 2020
To some small business owners their company’s statutory accounts may feel like a maths textbook written in a foreign language, but whether you speak the language of finance, prefer an entrepreneurial brogue or favour an artistic dialect, your statutory accounts may just have a thing or two (or five) to teach you about your own small business.
Here are five things you (probably) didn’t know about your small business’s statutory accounts.
1. Your bottom line is not the best measure of your business performance
The bottom line on the Profit and Loss account is the ‘profit for the financial year’. As the commonly used idiom suggests, this ‘bottom line’ is a vital statistic reflecting the net profit your small business generated during the previous financial year.
However, this net profit figure is NOT necessarily the best measure of your actual business performance, because it incorporates a number of factors that are outside the normal operating decisions that determine how well a business is run.
For example, net profit factors in taxation, which is determined by government rather than business owners; it accounts for interest payments, which are the result of financing decisions rather than operating decisions; and it includes deductions for depreciation and amortisation, which are accounting calculations used to average out the supposed decline in value of tangible and intangible assets.
In order to compile a more accurate assessment of a business’s performance most financial analysts go beyond the company’s net profit figure and instead calculate its EBITDA, or Earnings before Interest, Taxation, Depreciation and Amortisation. By adding interest, tax, depreciation and amortisation back into the bottom line analysts can determine how the company’s business operations directly affect its performance and profitability.
2. [ (Trade debtors – VAT) / total sales ] X 365 = average time it takes your customers to pay you
To understand how many days, on average, it takes your customers to pay you, divide the total amount of money trade debtors owe your business (less VAT) by the business’s total sales figure, and then multiply by 365. If the answer is around 30, this means your customers take an average of 30 days to pay your invoices, which is fairly standard.
A figure of 60 or more implies you’re being a little too lenient with your trade debtors, which could be undermining your business’s level of working capital. Time to renegotiate better payment terms or consider charging interest on past-due invoices, perhaps?
3. [ (Trade creditors – VAT) / total costs ] X 365 = average time it takes you to pay your suppliers
On the other side of the equation, dividing the total amount of money your small business owes your trade creditors (less VAT) by the total cost of sales, and then multiplying by 365, will tell you how quickly you pay your own suppliers.
If the answer is less than 30 days this means your business is probably paying invoices earlier than it needs to. While paying suppliers early can help foster stronger business relationships, if you need to improve your company’s level of working capital then taking slightly longer to pay suppliers is one way to achieve this.
4. Cash in year 2 minus cash in year 1 = your growth
It can be surprisingly difficult to decipher how fast a business is growing, but comparing how a company’s cash grows from year to year can serve as excellent shorthand for how fast the company as a whole is growing.
By subtracting the ‘cash and cash equivalents’ at the end of year one from the same line entry on year two’s cash flow statement small business owners can work out how much their cash position is improving on an annual basis.
5. Retained profit = the sum of all the profit your small business has ever made, less distributions
While many small business owners will choose to distribute some or all of their business’s net profits to shareholders by paying dividends, profit that is not distributed is classed as retained earnings.
Retained earnings represent the simplest and most efficient source of financing for a business’s growth, and can also serve to strengthen a business’s financial stability and improve its credit rating.
But the ‘retained profit’ line on a company balance sheet doesn’t just represent that year’s retained profit – it’s actually a cumulative figure that reflects the sum of all the profit that’s been retained in the business since the day it was formed, less any dividends already distributed to shareholders.