We can all read a profit and loss statement and a balance sheet right?
Most of us know that we are looking at a snapshot of financial performance at either a point in time or over a period of time. Financial literacy means that you are able to look at the information and begin to make inferences about future performance and recognise potential problems before they happen.
What most users of financial information miss is the connection between the documents and what the impact can be when a financial transaction is recorded or not.
Research suggests that 60% of companies that fail, fail because of poor cash-flow and cash management. The warning signs would have been there all along but not recognised due to poor or limited financial literacy.
As accounting information systems become more accessible, smarter and user friendly more small business owners and entrepreneurs will empower themselves and take responsibility for recording their own financial transactions.
This is most prevalent in the startup and critical phases of the business life cycle.
Once a quarter or even once a year the financials may be reviewed by a financial professional for preparing tax submissions and other reporting obligations. Not being financially literate means that you may be missing golden opportunities or making mistakes that could have been avoided and rectified early on.
Let’s take a look at a simple example:
As a stationary shop owner you buy pencils for 50 cents each, you have just ordered and received 500 pencils.
You have spent $250 on stock to sell to your customers.
You have 30 days to pay the supplier
Being financially literate means you understand that you need to sell all of these pencils within 30 days, before you need to pay your supplier.
The pencils are marked for sale at $1 each.
In other words you are able to recoup the cost of the pencil, have some cash left over to cover part of your overheads like salaries, rental, etc.
After covering these overheads you have a 10 cent Net Profit in the bank to apply to something else at some stage.
Unfortunately somebody stole one of your pencils. Not a problem, its a low value item and you have only lost 50 cents. Or have you?
Being financially literate will tell you otherwise.
First question, how many pencils need to be sold to make up the cost price of the stolen pencil?
Some people would tell you only 1, reasoning that a pencil costs 50 cents and it is sold at $1.00, easy done.
Actually, not so.
Remember there is only 10 cents net profit on a pencil after covering the costs of doing business.
You will now need to sell 5 pencils to replace the stolen pencil so your pencil sales need to increase by $5.00.
You will also need to sell a further 4 pencils to make up for the overhead costs that would normally be associated with the stolen pencil a further increase in sales of $4.00.
Only the 10th pencil you sell will give you that 10 cents net profit, or after a $10 increase in sales.
Being financially literate means you will discover this answer before 100 pencils have been stolen, lost or broken.
If you had waited until the end of the year for your accountant to pick this up, that is if they even do. You will still have $10 less in your bank account than you ordinarily would have and your stock will be 100 items or $50 lower than it should be.
You will be left wondering why your sales have increased but your net profits have decreased.
We have the perfect vehicle in Colour Accounting to give you all of the tools in your financial literacy journey.