Karen Szotek BSc ACCA
Joanna Grant BSc ACA
Whether you are starting a new business, expanding an existing business, or just trying to keep your business prospering there are three key factors you must always keep in mind - profitability, liquidity and solvency.
The primary aim of any commercial business is to make profit. The amount of profit depends on many factors, not least the needs of the business owners. If the business is to survive over the medium to long term then profit there must be. Your annual accounts show you whether the business has made a profit for the year via the profit and loss account (/sometimes referred to as the income and expenditure account or the receipts and payments account).
Your business may be able to survive in the short term without profit especially if it has built up reserves from previous periods but it can never cope without access to cash or cash equivalent to pay the bills. You may have been making plenty of profit but if this is all reinvested in assets or stock, or in the hands of your customers who have not yet paid their bills, you could still be unable to continue to trade. Liquidity must be watched constantly. You need to know the warning signs of trouble so that you can take early remedial action. A cash flow forecast may help with this.
You should not continue to trade if your business reaches the point where its liabilities exceed its assets. If the value of everything owned by the business plus everything owed to it is exceeded by the amounts it owes to other people then the business is insolvent. The balance sheet shows a picture of the solvency of the business at a specific point in time.