Understanding Your Financial Performance

One of your key financial reports is the Statement of Financial Performance, formerly known as the Profit and Loss Statement.

The basic formula for profit is:
PROFIT = INCOME − EXPENSES

Profit is calculated using only two of the five main accounting categories—income and expenses. The other three categories (assets, liabilities, and equity) are reflected in the Statement of Financial Position.

Accounting for Owner-Operator Labour

When analysing business performance, it is important to account for wages if you employ staff. Equally, if you are an owner-operator, you should also account for your own labour—either as a formal wage or as a journal entry (paper transaction) at year end.

This ensures the business reflects a realistic operating cost structure.

Thinking Like a Business Owner

It is important to view yourself as separate from the business. In a well-structured business, income is generated in two ways:

• As an employee, receiving a fair market wage for your time
• As an owner, earning profit above and beyond that wage

A successful business should generate profits after paying the owner a fair market wage. In other words, it should be more than just a job—it should reward ownership and risk.

Return on Investment (ROI)

Annual profit should be assessed as a percentage of the original investment, known as Return on Investment (ROI). As a general benchmark, a return of 20% or higher is desirable, and should exceed what could typically be achieved through passive investment such as a bank deposit.

The basic formula for ROI is:
ROI = Annual Profit ÷ Total Investment

This assumes the business was purchased using your own capital. Under this method, interest costs on borrowed funds used to acquire the business are not included in the calculation.

Example

If a business generates $30,000 profit per year after paying the owner a fair wage, and the business was purchased for $100,000, the ROI is:

$30,000 ÷ $100,000 = 30% ROI

If the business was funded through borrowing, the return should still be assessed based on the total purchase price, as the ROI measures performance of the underlying business asset—not the financing structure.