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Financial data, from having adequate accounting records, provides the means in which businesses can prepare financial reports, in order for management and/or owners to review how the business is performing.
Financial reports provide a summary of financial transaction which may reflect a past, present, or future state of the business. Financial reporting should also be carried out on a regular basis.
The 3 main financial statements used by a business include:
Profit & Loss Statements (also referred to as an ‘Income Statement’)
Balance Sheet (also referred to as a ‘Statement of Position’)
Cash Flow Statement
For companies these statements are required to be formally prepared annually, along with detailed ‘Notes to Accounts’ (outlining the basis on which the statements were based) in accordance with the Australian Accounting Standards.
A Profit & Loss (P&L) statement summarises a business’ sales revenue to its expenses, to calculate the gross profit and the net profit during a trading period, where:
Gross profit = Sales less Cost of Sales.
Net profit = Gross profit less any operating expenses.
EBITA = Net profit before interest, depreciation, amortisation and tax.
A Balance Sheet summarises a business’ assets and liabilities at a particular point in time, to calculate owner’s equity in the business (owner’s equity = assets – liabilities), where:
An asset is defined as something that the business “owns”
A liability is defined as something that the business “owes”
Owner’s equity is the net worth of the business to its owners
A Cash Flow Statement summarises all items of cash in-flow against all cash out-flow, to calculate the level of liquidity a business has over a nominated period of time, where the net cash balance at the end of a period is represented by the cash balance at the beginning of the period plus cash-in less cash-out.
In addition to financial reporting for statutory and review purposes, business owners and managers need to monitor the actual performance of their business against its goals and objectives. Effective ways of doing this is through:
Ratio analysis, to analyse a business’ profitability and liquidity (applied to the business’ income statements, balance sheets and cash flow statements), and
Tracking key performance indicators (KPIs), to measure how effectively the business is achieving its key objectives relating to the achievement of it goals
From the above tools, business owners can then ‘drill down’ into the areas highlighted where the performance of the business is not in line with its expectations and industry norms (i.e. the results and achievements of other similar businesses).
From understanding how a business has been preforming and its current financial position, business owners and managers can then gain a better understanding on where their business is heading, through forecasting.
Forecasting is the process of making predictions of the future based on past and present. The main forecasting techniques applied include:
Forecasting based on history, based on the premise that history can provide a trend, to predict a potential outcome and;
Forecasting based on market conditions, taking into account changing conditions and assumptions to predict a potential outcome
A budget is effectively a forecast (based on history or on assumptions on changing conditions, or both), expressed in either units or dollars, to provide a benchmark against which actual performance can be compared.
Comparisons of actual results to budgets assist business managers to identify whether corrective action may be required.
Variances, especially when analysed during a trading period, can indicate where forecasted results may vary from expected results.
Businesses seeking funding - from external parties such as funds, financiers or other shareholders - will normally require a Financial Plan to be complied. A financial plan usually provides details such as a projection of the business’ financial position, resulting from the accumulation of its business’ activities (such as revenue generation and expenses required to run the business, plus other aspects such as future investments required and liabilities to be paid).
Financial Plans are usually based on historical data, plus other known variables and assumptions, to provide future projections, which would normally include an estimate of the business’ cashflow requirements. Projections for a future period would usually be no more than 12 months in advance.
The extent to which a Financial Plan is prepared would be based on who will be reviewing them. For example, if the financial plan is to be reviewed by an external party it would normally be formal in nature and would normally include:
Details of the owner/s and their up-front investment;
Historical financial reports (for the past 3 years); including the profit & loss statement, balance sheet and cash flow statement
Expected revenue compared to costs, for a projected profit & loss statement;
A cashflow forecast and analysis;
The business structure
H&R Block can assist you with all financial reporting requirements for your business.
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