As written for Fargo, INC
It seems logical that a business owner would have in-depth knowledge of their financial performance, but the reality is that most businesses happen from a dream or hobby and the owners learn by trial and error as they grow.
Interpreting and controlling financials is almost a mystery and we see what that means when we get a loan application from a business and their financial statements are riddled with numbers that seem to not make sense! If you are unsure of the value of reviewing your financial statements or understanding what they mean, it’s time to dig in, analyze what’s happening behind the scenes and get down & dirt with your financial statements!
Let’s take a peek at the different statements and why they are important.
INCOME STATEMENT – this is also known as a Profit and Loss Statement. At a macro-level, it shows how much you had in sales, what the cost was for the items or services you sold, other business operating expenses, and ultimately whether or not you made a profit. But when you dig into the details, you can find trends.
- Are your sales increasing or decreasing compared to previous months or years?
- Are your cost of goods sold in line with your industry averages?
- Do you have any expenses that seem too high or have a negative balance – if so why?
This statement reflects a period of time – whether it be a single month, year to date, or full year of income and expenses.
BALANCE SHEET – this statement shows what you own and what you owe. It shows the book value of your assets, if you have cash in the bank, how much money customers owe you (accounts receivable) if you have built equity in the business and the balances of your liabilities such as accounts payable and outstanding loans. This statement reflects a point in time, or the balances as of a single date. It is a cumulative view of your business since the beginning.
CASH FLOW STATEMENT – this statement shows the impact of incoming cash and outgoing cash and if you have enough to run your business, also known as working capital. Many people thing this is the same as the income statement – in some ways it is similar, however, things like depreciation, asset purchases and principal payments on loans that don’t appear on the income statement show where the money has come from and where it has gone. This statement is also a reflection of a period of time – such as monthly, yearly, etc.
Not any one statement is more important than the other as they all serve a different purpose for managing your business and financials. And they all tie together. Changes in values on the balance sheet come from activity on the cash flow or income statements.
Another important thing to note is that your reports are only as good as the data going into your bookkeeping system. As the saying goes: garbage in, garbage out. It is advisable to enlist the services of an accountant or other trained professional to help setup your bookkeeping system, procedures and best practices. Don’t underestimate the impact of incorrect accounting and the impact it can have on your cash management, tax liabilities and overall performance of your business.
As an owner of a business, be curious – if you aren’t doing the books yourself, ask questions. Lots of questions! If numbers don’t seem to make sense to you, figure out why. It is so easy for errors to happen and things to end up being logged incorrectly through the bookkeeping process. Look at trends. How are the reports as compared to last year? Last month? Are sales up or down – does it represent what you believe to be true?
Unless you have a trusted & proven CFO as part of your leadership team, you are likely to be the only one that can sense if the numbers seem right. If you don’t know what to ask, look for training or reach out to your accountant to help you learn what to look for and how to analyze your financial statements. Setup a schedule to review your reports – at minimum monthly. And don’t forget to also periodically check things like the aging of accounts receivables (money owed to you), accounts payable (money you owe to others), bank reconciliations and account detail listings of your expenses.
You have the ability to control and change how your business performs financially.
After all, you may be in the business for fun, but I’m pretty sure you also want to make money doing it!