Did you do a full year-end financial analysis of your business last year? If not, then you’ve set your business up for failure. Even if you end up profitable this year, you leave up to 50 percent of your revenue on the table without a plan based on last year’s financial analysis.
Don’t get too discouraged if you answered no. Over 80 percent of the people I begin coaching are not doing a year-end financial analysis!
Why is this a big deal?
Because it’s like playing a game without keeping score. You might think looking at your bank account is keeping score, but it’s not.
This two-part series is going to teach you how to conduct a year-end financial analysis that lets you know two important things: Where your business is financially, and how it got there.
Let’s get started.
The Three Key Documents of a Year-End Financial Analysis
There are three key documents that make up your year-end financial analysis. These are:
- Profit & Loss Statement ( P&L )
- Balance Sheet
- Statement of Cash Flows
This article is going to focus on the profit and loss statement, but first we’ll briefly introduce each of these three documents.
Profit and Loss Statement
The profit and loss statement is a theoretical look at how much money you may or may not have made in a given amount of time. It can be either cash or accrual based. If you’re unsure of the difference, we’ll be discussing it a little later.
The balance sheet shows the tangible end-results of your profit and loss statement. It lets you know how much revenue you actually generated during a time span, and also shows how much debt you have accrued.
Statement of Cash Flows
The statement of cash flows shows you where your cash is going. It lets you know exactly where your cash is coming in and going out.
The Difference Between a Cash and Accrual Based Profit and Loss Statement
Basing your profit and loss statement on accrual means transactions go on the books the moment they are initiated. Basing it on cash means transactions go on the books the moment the cash leaves or enters your account.
Although cash-based is easier, an accrual-based profit and loss statement tells a more accurate story of when profit or loss occurred. Let’s look at a Dentist as an example.
Our Dentist does $5,000 worth of billings in July. The cash doesn’t actually get to his account until September, which is caused by billing issues. An accrual-based profit and loss statement would show this profit for July. A cash-based profit and loss statement would show this profit in September.
Under the Spotlight: The Profit and Loss Statement
There are technically four sections of a profit and loss statement, but the fourth contains information only your Accountant has to worry about. Your focus is on the top three sections. These are:
- Total Revenue
- Cost of Goods Sold
Section 1: Total Revenue
The total revenue section shows all of the revenue you have generated. It should categorize your streams of income in a way that is specific enough to show meaningful data, but simple enough to use in a meaningful way. The happy medium is between three and seven line items.
Section 2: Cost of Goods Sold
The cost of goods sold section shows the direct costs of producing and selling each of the line items in the total revenue section.
Section 3: Expenses
The expenses section is for your overhead costs. These are the costs that don’t fluctuate based on your business volume. Costs like rent and utilities go under expenses.
Making Sense of the Profit and Loss Statement
What software do you use for your financial analysis? If you don’t currently have a software, then I recommend Quickbooks. It has all the features you need to conduct your year-end financial analysis. The first step is to run a month-by-month report in your financial analysis software.
The second step is to identify the biggest sources of revenue in your total revenue section. What products or services are really making you money?
The third step is to look for trends in your month-to-month report. We’ll end with the four questions you want to ask when looking at your profit and loss statement:
- What are my biggest revenue items?
- What line items are up and down at random?
- What line items have a consistent upslope or downslope?
- What are my biggest profit items?
Part two of this series covers the remaining two sections of the profit and loss statement, as well as the balance sheet and statement of cash flows. Be sure to read it in order to complete your year-end financial analysis.