How to financially assess your business?

Do you know how to properly assess your business by processing your financial data into reports? There are three levels to assess your business’ performance: the balance sheet, the income statement, and the cash flow statement. 

Balance Sheet

A balance sheet uses this formula to give you a simple illustration of how your business is doing.

Asset = Liabilities – Owner’s Equity

Assets are categorised into two parts: current and noncurrent.

1. + Current assets are composed of assets that can be easily converted into cash, which can be immediately used to support the business. The following are part of the current assets:
   1. Cash and Cash Equivalents: Cash on hand, cash in bank, and short-term investments;
   2. Accounts Receivable: Accounts receivable and allowance for doubtful accounts (a percentage of your receivables that is used in consideration of uncollectible transactions); and
   3. Other current assets: Inventory, Prepaid expenses (advanced payment for operating expenses), and others.
   You can use the cash and cash equivalents plus the accounts receivable to compute how liquid your business is compared to its current liabilities. This is to see if the business can pay its current liabilities. Inventory is not included in the computation because it takes some time to convert inventory into cash.
2. + Noncurrent assets are assets that have a useful life of more than a year and cannot be liquidated quickly. Noncurrents are composed of the following:
   1. Property, plant, and equipment: Land and land improvements, buildings, leasehold improvements, equipment, furniture and fixtures, construction in progress, depreciation (a credit to the overall asset value as it reaches its useful life); and
   2. Other noncurrent assets: Unrestricted long-term investments and trusteed investments (income-generating assets), and deferred financing costs (costs related to the issuance of debts or loans).

Liabilities

Liabilities are also categorised into current and noncurrent.

1. + Current Liabilities are short-term obligations due within one year. Below are accounts under current liabilities:
   1. Accounts payable (goods or services on credit); and
   2. Current retirement on long-term debt: a portion of the long-term debt for a one-year period.
2. + Noncurrent Liabilities are long-term debts that are not yet due for the next 12 months. It is important not to forget about the noncurrent liabilities, as these are still outstanding debts that have a due date beyond 12 months.

Owner’s equity

Owner’s equity is the monetary investment of the owners in the business’ operation and growth. Owner’s equity is commonly composed of the following:

1. + Capital contributed: the money invested in the business;
2. + Revenue / Retained Earnings: net income after deducting the dividends paid out to the owners or shareholders; and
3. + Withdrawals: personal withdrawals of the owners.

A balance sheet shows a business’ financial position over a period of time, while an income statement measures the performance of the business.

Income Statement

An income statement is also known as a profit and loss statement. This report shows your profitability as a business—whether you are earning or losing money. 

These are the accounting terms inside the income statement:

—Revenue: sales and sales return – is the total collected money for the goods and services you produce, excluding the operation’s expenses.
—Cost of sales: direct labor, direct materials, overhead, and inventory (beginning inventory + purchases – ending inventory) – refers to the direct costs incurred to produce the goods or services. Reducing the cost of sales can help you increase your profit without having to increase your sales. However, reducing the cost of sales should not be taken lightly, as it might affect the quality of your product, which might affect the retention of your customers.
—Gross margin illustrates the sustainability of your business over time. (Formula: Gross margin = Revenue – Cost of sales)
—Operating expenses: accounting fees, payroll, rent, utilities, depreciation expenses, interest expenses, and other indirect costs are indirect costs necessary to continue doing business in order to generate sales.
—Profit is the term used for the net income after the cost of sales and operating expenses are deducted from the revenue.

An income statement reveals the ability of the business to generate a profit, while a cash flow statement shows you how much cash is available for a certain period.

Cash Flow Statement

A cash flow statement shows you how much money is coming into and going out of your company during a specific time period. This includes cash flows from operating, financing, and investment activities of the business.

The cash flow adjusts the information from your income statement to see the precise amount of cash you have on hand. A great example is that of the depreciation expense—the depreciation is a contra-account to adjust the cost of the asset throughout its useful life; hence, the business’ does not pay the depreciation expense. 

There are three sections in a cash flow statement:

• Cash flow from operating activities: cash earned and spent on the business operation;
• Cash flow from investing activities: cash earned or spent from investments such as purchasing equipment or other investments; and
• Cash flow from financing activities: cash earned or spent to finance the business using loans, credits, or owner’s equity.

As your accountants, Star Advisers can accurately prepare, deliver, and explain these reports for you to assess the performance of your business. Contact us now so we can send you a proposal to be your accountant!