There are three important financial statements that all online sellers should know, if not thoroughly then at least superficially. These are the cash flow statement, the balance sheet and the profit and loss accounts. While being an online seller is a busy job, and many feel they don’t have time to sit down and focus on their finances as long as business is running fine, it really is crucial. And more importantly it can become a massive benefit for you when you strategically try to grow your business.
The cash flow statement
Being in control of your cash flow is essential, if you want to make sure you stay on top of your numbers and hence, your business. As the name indicates, cash flow explains the flow of cash going in and out of your business. Running with an unhealthy cash flow can seriously hurt your business and in the worst case force you to shut down. Best part is, in essence the cash flow statement is actually quite simple.
Cash flow from revenue + other sources of cash – uses of cash = change in cash
Do you know your cash flow? The real problem happens when more cash leaves the business than comes in. But that doesn’t mean you have to worry if this happens once in a while. That’s not necessarily a sign that the business is doing badly. The problem arises if you’re not prepared for it and end up in a situation where you can’t pay your bills for a longer period of time. Therefore, planning is everything.
It’s always difficult to plan ahead, but you can either look at past years cash flow or if you don’t have that perhaps you can find some overview of your income and expenses from the previous year. This will help you. When did you have money going in and when did you find yourself with a deficit?
Once you have a rough idea start using the information. Avoid putting yourself in situations where you know you won’t be able to pay the invoices. Don’t be sad if there’s a period where you can see you haven’t sold a lot, that’s normal. Most products sell more in certain seasons than others. That’s not the problem; the problem only arises if you’re not aware of this.
Knowing your cash flow will also allow you to make sure you have more stock for busier periods. While it’s annoying when you can’t pay your bills, it’s certainly also annoying to run out of stock when you know you could have sold more.
The balance sheet lets you know how much you owe and how much you own. That’s pretty nice to know, right? The two important terms you should know are assets and liabilities. Assets refer to what you own, and liabilities to what you owe.
So assets can be divided into two: long-term and short-term assets.
Assets – or what you own
Long term assets, such as
- Your house (if owned), computers, vehicles, machines, etc.
Or short term assets, such as
- Cash in your bank (or in your madras), stock and outstanding payments from customers as well as money stores with PayPal or eBay.
One mistake that many sellers make is that they account for the amount of cash the stock is worth. That is not the correct way to do it. Assets should be accounted for at their original cost, even if the market value is higher. Don’t trick yourself, because you think the stock you bought is worth a lot more than you paid for it. It doesn’t necessarily mean that you can actually sell it at that price.
Liabilities – or how much you owe
The other thing which is really important is liabilities. Under liabilities come
Short term liabilities, e.g.
- Creditors (i.e. wholesalers, suppliers, unpaid bills), bank overdrafts or loans (bank, friends and family etc.)
Long term liabilities, e.g.
- Mortgages and other long term bank loans
This is simplified, but covers the most essential posts of what you owe to third parties. Note that in this we have not included retained earnings or your own capital (equity) which you have put into your business in terms of liabilities. Why? Because what you really care about is what you’re worth. You can figure that out by calculating what accountants call ‘net assets’.
Net assets – or how much you’re worth
Really not rocket science, it simply represents the difference between how much you own and how much you owe to third parties. If you own more than you owe it’s generally a good sign, if not then you may have a real issue unless you manage to sell your stock or other long term assets at a much higher price than what they’re accounted for.
Profit and loss accounts
So now it’s time to go through the last financial statement. This account can be updated frequently and will tell you how much profit or loss a business is making.
It’s probably pretty obvious that this statement shows you how you’ve made a profit or a loss, but the reason it’s a good idea to actually do the profit and loss accounts is that it can tell you where you may need to cut costs or where your biggest losses are found.
The top section of a P&L account is known as the trading account for a business that buys and sells items. What is known as the gross profit is calculated by deducting cost of sales from turnover, also referred to as revenue.
The turnover is calculated rather easily, simply be multiplying number of sold items with the average price of your product. Let’s say we sell phones. Last week we sold 50 phones at £45, giving us a turnover of £2250. We paid £1000 to buy the 50 phones.
This leaves us with a gross profit of £1250.
But as all online sellers will know it’s not as simple as that, because any business will as well incur overhead costs. Normally these costs cannot be directly related to each sold unit, but with eBay and Amazon sellers there will be fees related to each unit. Nonetheless, we will categorize these as overheads as well, to make it simpler.
The overheads could be:
- EBay fees
- PayPal fees
- Other expenses in relation to the business
The profit you (hopefully) end up with once all these calculations have been made is called the operating profit. It’s important to distinguish, because you cannot include income that does not come from the normal activities in your business in this. The reason for this is that it will be misleading and won’t be helpful in predicting future income.
Once we’ve found the operating profit we can then add income from outside the normal activities of the company as well as deduct any interest on money which the company has borrowed during this period. This leaves us with the net profit or in other words 'what is ours’.
The above examples are simplified and an accountant would add much to this. But you don’t have to be an accountant. What you need to know is the most important things relating to the finances of your business.
Are you using any of these financial statements? If not, what is keeping you from using them? Share your thoughts via comments below.