One of the biggest challenges for creatives can be understanding and keeping up to date with the accounting side of their business. Understanding the numbers in your business is a vital skill that can remove much of the guesswork when you make decisions regarding the profitability of your work. When you have access to real data and can identify concrete trends across the profitability of the products and services that you offer, you can make decisions based on real information, not just a gut feeling.
As a jewellery maker and designer myself, I completely understand that managing the books can be a difficult and tedious task, because before I changed to a creative career, I was working in the accounting industry. So today I want to help you gain a better understanding of your numbers and the areas where you generate the most and the least amount of money, by explaining two must-have 'business report cards' and guiding you through how they can assist you to monitor and assess your business profitability.
1. Profit and Loss Statement
Your Profit and Loss (P&L) statement shows how your business performed during a period of time. There are three main factors of a P&L statement:
Revenue: Any sort of income you earn, whether it be from sales of products or services, commission etc; and
Expenses: Any sort of expense you spend in the course of running your business like:
- Cost of goods sold
- Supplies and materials (raw materials you use to make your products – fabric, beads, glue, metal etc)
- Advertising (Facebook ads, Google adwords, marketing materials like business cards, post cards etc),
- Fees and charges (online shop fees, PayPal/credit card transaction fees, bank fees, EFTPOS fees, website hosting fees, stall hire fees, consignment fees)
- Office expenses (stationery, printing)
- Subscriptions (magazines/journals related to the industry your business operates in)
- Utilities (electricity, gas, water, telephone, wifi)
- Insurance (home and contents, theft, public and product liability)
- Professional services (legal, accounting)
- Repairs and maintenance (equipment your business uses)
- Wages, superannuation etc.
(Please note this is a example of the kind of revenue and expense items a typical business may have - yours may vary.)
COGS (cost of goods sold): COGS refers to the costs directly associated to the production of a product. This includes any material costs, labour, shipping and other costs to transform the product to be ready for sale. Determining the COGS can be one of the more difficult things to calculate and the value changes depending on which valuation method you use when you’re doing your books. But to explain the concept simply, let’s go through an example. Let’s say, I have $100 worth of beads in inventory at the beginning of the month. I buy an extra $20 worth of beads during the month and have $50 worth of beads at the end of the month. How do I calculate my COGS?
(Beginning inventory: $100) + (Purchases: $20) – (Ending inventory: $50) = Cost of goods sold: $70
For more information or assistance developing your specific COGS, have a chat with your accountant!
Now here are some key formulae for a P&L statement:
- Revenue – Cost of Goods Sold (COGS) = Gross profit
- COGS = opening stock + purchase – closing stock
- Gross profit – expenses = Net profit/net loss
Remember to keep receipts for EVERYTHING you purchase, whether it be offline and online. For online purchases I like to save each receipt into a specific folder on my computer (and I also back it up regularly). You might prefer to print out your receipts and keep them organised in folders dedicated to a single month or specific financial year.
2. Balance Sheet
Your business' balance sheet shows your assets, liabilities and owners equity as at a specific date.
Assets: Cash, accounts receivables (money you have invoiced your clients that you have not yet received), inventory, investments, tools and equipment and any other asset your business owns
Liabilities: Money that your business owes (you have been invoiced for a service you used and have not yet paid or materials you have bought but not yet paid for), accounts payable, bank/credit overdraft and any other debt
Owners Equity: Anything that is left over, once liabilities have been paid for from assets. If your equity is high, it means that your assets outweigh your liabilities, if your equity is negative, you’re losing money, and your business isn’t making enough money to carry the level of debt it’s carrying.
The basic accounting equation for a balance sheet is: Assets = Liabilities + Owner’s Equity
Ageing receivables and payables.
If you sell products or services, you’ll need to keep a track of the ageing of receivables and payables. Ageing is usually broken up into four categories: 0 – 30 days, 31 – 60 days, 61 – 90 days and 91+ days.
When you issue an invoice to a client or customer, the longer the invoice goes unpaid, the higher the likelihood that you may not get paid at all. It’s important to monitor invoice payments, so you can chase up a client if the invoice becomes overdue. A debt is said to 'go bad' when the client doesn’t pay or can’t pay, which may mean you need to write it off as a bad debt. Not getting paid is certainly not good for your business!
Other useful accounting tips
Set up a dedicated bank account
It’s a good idea to set up a dedicated bank account for your business. Therefore, whenever you update your financial information, you don’t need to wade through all the transactions to pick out the ones that are personal and which ones are business-related transactions.
Let technology help your keep track of your data
There are lots of techonology options to help you manage the data your business sales generate, so you can turn it into information that’s accurate, relevant and timely for decision-making. If you’re just starting out or your revenue and expenses are quite straight forward, you could use something as simple as an Excel document to keep track of everything. Otherwise, cloud-based accounting software such as MYOB, Xero or Waveapps offer a host of benefits - though some might incur a monthly fee (but most have a free trial period so you can see if the investment works for your business needs).
Make accounting part of your weekly or monthly routine
Depending on the level of activity your business generates, you should update your financial information weekly or at least monthly to give you a good indication as to how your business is performing. Choose a day or even half a day each week/month, and dedicate yourself completely to managing and reviewing your P&L and balance sheets. Remember, this day is important to spend on your business and not in your business.
Do your own books (or at least keep a close eye on them!)
When you’re just starting out, I totally recommend you do your own bookkeeping so you can understand what is happening in your business, rather than outsourcing it straight away to a professional bookkeeper or accountant. As your business grows, and your business generates more activity, it may be worthwhile bringing on a professional to assist, so you can concentrate on the things you do best and provide most value to your business. Bu having said that, even when you have outsourced these tasks to other people, it’s still important that you understand the accounting and continue to review the numbers from month to month.
Get started today
If what you've read sounds great, but still a little overwhelming - never fear. Over at my website I’ve created a customisable P&L template for you – so you can use this immediately for your business! The template contains instructions to guide you. Try it out and I'm sure you'll get addicted to how knowing how your business is going financially. Happy accounting everyone!
NOTE: This article is intended as an EDUCATIONAL GUIDE ONLY and is NOT INTENDED to be taken as specific financial advice. Please discuss your business' financial performance with a qualified accountant, solicitor or financial advisor.
Monica Ng left her accounting career at the end of 2013 to run Geometric Skies, her Etsy jewellery business, alongside her jewellery and object design studies at the Design Centre in Sydney. Find Monica at her blog or on Instagram @geometric_skies.