How to understand accounts in your creative business
Being able to understand accounting terms and accounting concepts will help you in your business in the short term and the long term. You need to be able to understand the financial health of your company from its financial statements and the annual reports. These reports will help you see where your company is now and where it will be in future.
Do you understand accounts?
The accounts will normally consist of the profit and loss account, the balance sheet, a cash flow statement and the annual report.
The profit and loss account will show you how much money you have made during the accounting year. It will be shown as the following
Revenue - this is the total sales that you have made during the year. This figure will be shown net of VAT if you are registered.
Cost of Sales - this amount is the cost that directly attributes to you being able to sell your services. This may be software, services or products that directly relate to you being able to provide your service.
Gross Profit - this is the difference between the two totals above. It is the revenue less the cost of sales. This gives you the amount that you make on each project, job or sale that you make.
EBITDA - Earnings before interest tax depreciation and amortisation. This is used to be able to compare your business to similar businesses that work in your niche. We want to strip out the differences in the business so we can see how they perform if we compare like with like. If your business is not performing as well as one of your competitors we want to try to understand why?
Overheads - These are the expenses of your business that we cannot attribute to the cost of delivering your services to your customers. These may be the cost of Rent, Rates, Travel, Software and Wages. These are the expenses that you pay to keep your business running on a day to day basis.
Net Profit - This is the profit that you are left with after you have paid your overheads, taxes and cost of sales. This is effectively the money that you are left with once all the expenses and bills are paid.
The Balance Sheet - this shows you the financial information of the company at a point in time. It is a snapshot of the company at the year end.
It will tell you the assets that the company has - the bank balance and any debtors or accounts receivables that the company has
It will also tell you the liabilities or the accounts payable the company has at the end of the year.
The difference between the Assets and the Liabilities is the amount of money that the business owners can take out in dividends and shares
Why do you need to understand?
Knowing this information will help you see the financial health of your business. You need to know how your company is doing as a small business owner. Are you doing better than last year or do you need to get help in your business?
The sooner you know this the quicker you can take action to keep your business healthy and successful.
These are simple but necessary skills that you need to learn as a business owner. You need to be able to learn them now if you are managing a business as a creative freelancer or a creative agency.
How do I learn how to understand them?
Spending time talking to your accountant is one of the best ways to learn. Asking questions of the accounts and asking what the numbers mean is the best way. Your accountant can tell you what each of the numbers mean in the accounts and how they are derived.
They can explain to you what business transactions are included in your accounts and how the totals for your expenses are calculated.
Getting access to your accounting software such as quickbooks or xero will help. Unless you have some accounting knowledge of debits and credits when you get access I would not change any transaction in there. I would only use it to view and look at the company accounts.
Take a look through and ask questions the next time you speak to your accountant and ask for explanations of the accounts in your software.
Make better decisions?
When you understand the accounts better you can make better decisions in your business. You can understand more how the business works and how it earns money. What the key performance indicators are in your business and how you can use them to grow and make more money.
You can see what parts of the business that you need to concentrate your efforts on to improve. You can see when you can invest and when you need to save your money for your taxes and bills.
They help you in your business?
Knowing the key performance indicators in your business lets you take action to improve them. If you see that the cash account at the bank is low you can take action to collect your debts quicker. You can monitor that number over a period of time and see how it increases.
Getting the debts paid quicker means that you have more money to spend in your business. You pay less on financing costs if you have a credit card or overdraft and you reduce the costs and expenses in your business.
You can carry out a process of improving the areas that are weak in your business, the areas that are shown up by the numbers in your accounts. Once you improve these numbers the business will improve overall.
Next Steps
If you need help in understanding your accounts further please reach out to us for more help and we can arrange a call to discuss your needs and how we can help improve your accounting knowledge.