Many business owners see their success as the direct result of a strong work ethic and good marketing plan, but we know the real secret: it’s all in the accounting! Good accounting sustains a business, and provides data that will help the owner make the smartest decisions about where to go next.
There are many different reports that tell a business owner what the “financial” health of their company is, but the balance sheet, income statement, and statement of cash flow provide key data to drive decision making at any stage of business. Startups need to make sure their business has a good foundation. Businesses in their second or third year need to evaluate how they’re doing and what needs to be changed. By understanding the following three reports, businesses will better unlock their true potential.
1. Balance Sheet
The Balance Sheet is a snapshot of the financial position of your company at a certain point in time. This includes assets (what your business owns), liabilities (what your business owes), and owner’s equity (the owner’s stake in the business). Included in this report is your cash balance and liabilities.
On a balance sheet, it’s important to understand the order in which the assets and liabilities appear, and whether they are considered “current” or “long-term”. Here is a quick break down to help you read and understand your balance sheet:
Assets often appear in the order of liquidity, or how quickly those items would be converted into cash in the normal business operation, which is the reason why cash is usually the first item on the balance sheet.
Cash, accounts receivable, inventory etc. are considered current assets because they can most often be converted to cash within a year.
Buildings and equipment are considered long-term assets since they normally would not be converted into cash within a year.
Liabilities are also appear based on liquidity, but for money going out, with accounts payable, taxes payable, payroll payable etc. appearing first. These are all current liabilities.
If you have liabilities that cannot be paid within a year, they are considered long-term, i.e. debts with terms over a year.
TIP: If you captured all of your accounting information correctly, both sides of the balance sheet equation should be equal.
2. Income Statement
An income statement shows the revenue, expenses, and the profit/loss of your company for a specific period of time (month, quarter, annual). Profit/loss is important because it gives you an idea how profitable the company is overall. Items in the income statement fall into two categories: revenue, the income earned for services performed or goods sold that period of term, and expenses, the costs incurred during that same period. Subtracting expenses from revenue will provide your profit/loss or net income/net loss.
TIP: Make sure to also factor in overhead costs such repairs, utilities, insurance and legal fees into your operating expenses to ensure your net profit is accurate.
3. Statement of Cash Flow
The statement of cash flow shows the movement of cash in and cash out for the time period. It is one of the most important reports for small businesses and startups because it allows you to see how readily a company can meet its debt and interest payments.
The statement of cash flow usually gets broken down into three categories: operating cash flow, investing cash flow, and financing cash flow:
Operating cash flow shows the money coming from normal business activities.
Investing cash flow shows money from investing activities such as equipment purchases.
Financing cash flow is money related to debts, contribution or distribution from owners.
TIP: To calculate your ending cash balance, take the beginning cash balance, add cash inflows and then subtract cash outflows.The final result shows the net change in cash for the period.
Financial reports tell the past, present and future of your business. The past is the decisions you made in the beginning and how they affected your financial gain or loss. The present is a snapshot of what decisions you are making right now. The future is what you decide to do with the information these reports have given you. How you use this information will be the defining factor of your business’s growth or its demise. You can also use this information to benchmark your financial data with other companies in the same industry to see where you stack up.