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According to Chinmay Ananda who is the Director & Facilitator Finance Academy Australia there are two rules in business:
Rule #1: Always earn more than you spend.
Rule #2: Never forget Rule #1.
To know if a business is earning more than it spends at any given point in time, stakeholders must know the numbers which are on the financial statements. Unfortunately, many people find it hard to understand financial statements and depend on their accountants – mainly because they don’t understand the basics.
To understand financial statements, you don’t need an accounting or financial background. You just need to know the four critical things that happen in every business:
- Money comes in
- Money goes out
- Money’s supposed to come in
- Money’s supposed to go out
Whenever one of these financial transactions occurs, it gets recorded in a book of accounts or accounting software and two basic financial statements are prepared: a balance sheet and profit & loss statement.
If you’re aware of what’s happening in these four areas of financial transactions then you can use a profit & loss statement as a thermometer that will tell the temperature of the business, and the balance sheet will show why the business has that temperature.
It’s important to understand that you are not your business. Owners are treated separately.
Money comes in
Money can come into the business in two ways:
- When a business sells a product or service and the customer pays for it. It gets recorded under ‘Income’ on the profit & loss statement.
- When a business borrows money; it gets recorded as ‘Liabilities’ on the balance sheet.
Money goes out
If money is going out of your business, it either becomes an expense or an asset.
- Expenses include: bills, salary, interest paid on loans, tax. All these get listed on the profit & loss statement as ‘Expenses’.
- Assets include: purchase of land, building and machinery. These get listed on the balance sheet as ‘Fixed Assets’.
Money’s supposed to come in
This is money supposed to come into the business within one financial year. Usually it will be money customers owe to the business; they are called debtors. This gets mentioned as ‘Current Assets’ on the balance sheet.
Money’s supposed to go out
This is money supposed to go out of the business within one financial year. Usually all payables or money the business owes gets mentioned here. It will be under the heading ‘Current Liabilities’ on the balance sheet.
Get on top of these four financial transactions and you will be more confident in making informed, profitable decisions in the business.
All of that said, good financial management may not always guarantee success in business. However, poor financial management alone can bring down any organisation!
The Business Enterprise Centre is a community based not-for-profit organisation established to foster the growth of business within the Central West of NSW. We are managing agents for the NSW government Small Biz Connect Program, Australian Government ASBAS and NEIS program. To find out how we can assist your business contact the BEC on 63620448 or email firstname.lastname@example.org