It’s all the smoke and mirrors that make it seem harder than it is. I’ll prove it to you using only what you already know. Let’s start with your business and the things that spin around your head every day about it.
Sales. Advertising. My bank balance. My new truck. People who owe me money. My credit union loan. Wages for the staff. Rent. People I owe money to. Insurance. Travel.
Nothing hard there right? Let’s rearrange them a bit.
- Sales – that’s our favourite part let’s leave them here on their own.
- Expenses- Lump the everyday spending together here. Advertising. Wages. Rent. Insurance. Travel.
Let’s get two more groups going over here with the rest:
- People who owe me money
- My bank balance
- My new truck
- People I owe money to
- My credit union Loan
Now comes the smoke and mirrors part; let’s how investors, banks and accountants see our business.
Everyday things – Profit or Loss
- Expenses: Advertising. Wages. Rent. Insurance. Travel.
Subtracting your everyday expenses from your sales is what gives your profit or loss. See? Not that hard. And your profit is what you get taxed on. Sales minus expenses = Profit
All the other stuff forms the balance sheet. No don’t run away – look its easy!
Good Things – Assets
- People who owe me money – Debtors
- My bank balance – Current Asset
- My Truck – Fixed Asset
Bad Things – Liabilities
- People I owe money to – Creditors
- My Credit Union Loan – Long Term Liability
But why do they need to do that and why do I care?
This is the only language your bank understands. Just look at what they do with it to pass judgement on you!
It sounds interesting, but it simply means how much more you have than you owe.
Divide your good things above (assets) by your bad things (liabilities) and put a :1 after it.
So if your assets add up to 100,000, and your liabilities add up to 50,000 divide 100,000 by 50,000 getting 2. Your liquidity ratio is 2:1. You have twice as much as you owe. Do you see? Remember, all your own information. Nothing scary or confusing after all, is there?
So one of those things that you ‘have’ is people who owe you money. You don’t physically have it cause it’s in your customers pockets, but make no mistake, it’s yours. What the bank will want to figure out, is how long those people owe you the money, because as you already know, the longer they owe you the less likely it is you will get paid. They basically want to test the likelihood of that potential asset becoming actual. How can they possibly do that without ringing up your customers?
First find out your average daily sales, by dividing your sales figure for the year by 365. Then divide your ‘people who owe you money’ or Debtors figure by that. The answer will be how many days on average it takes you to collect your money. This is scarily accurate. Try it! Sales 36,500= average sales of 100, If Debtors =6,000 Debtors days = 60. Obviously the lower the number the better.
Knowledge is Power . Go for that loan or investment knowing exactly how the other party is evaluating you. It gives you clarity and negotiating power.
Did this help prove accounting IS easy?