Your financial statements are the backbone of your business. They can:
Guide you to make informed decisions faster
Help you to build a budget
Reduce your stress load
And show the pathway for achieving your goals
I am often surprised by the number of people that tell me they only keep a mental record of their spending. Or that they just have a big box of receipts and statements that they give to their accountant at the end of the year.
These are an easy traps to fall into.
It doesn’t matter how great your memory is. The fact is, humans are fallible and our memories can easily be distorted or (lets be honest here) completely lost. We get distracted by something shiny, and that oh-so-important information falls to the wayside. AND the IRS won't accept, "oh, I don't really remember" as a valid answer to their audit questions.
Financial statements provide a complete overview of the health and status of your business at your fingertips, if you only learn to understand them.
I want you to be best friends with your financial statements. And the first step is to not be afraid!
Each of the below reports is like a puzzle piece. Alone, it only gives you a small piece of the picture, but when combined, you get a great birds-eye view of how your business is operating.
Balance sheet
The balance sheet tells you what you owe (liabilities), what you own (assets), and what is leftover (capital or equity). Unlike the other two statements that follow, the balance sheet is as of a specific date in time rather than over a period of time.
Think of it more like a snapshot or picture of the financial health of your business as of a specific day.
The balance sheet is aptly named as the two columns, 1) assets & 2) liabilities + equity must always balance/equal. If they don't, something is wrong and needs to be corrected. If you aren’t confident in your abilities, you should rely on your bookkeeper or CPA to find and correct any errors.
It may be easier to think of the balance sheet as the statement of financial position. This statement shows a comprehensive overview of your business finances.
Statement of cash flows
Where did your cash come from and where did it go? The answer to these questions is in the statement of cash flows.
This report is broken down into 3 sections:
Operating activities- your day to day expenses and income. This includes accounts receivable, accounts payable, wages, inventory, etc.
Investing activities- the purchase or sale of long-term investments like property or equipment.
Financing activities include loans and dividend payments (if you have shareholders)
This report is often underutilized. It can be incredibly helpful in determining your current cash status. The data can be used to tell you whether you have enough cash for upcoming expenses, like payroll. You can hide a lot of operating problems under a blanket of profit; the statement of cash flows exposes any deeper issues.
You can compare it to your own personal bank account, for example. Say you have money in there, but you notice that at the end of every month you have a little less than the month before. This is a key symptom of a negative cash flow. More is going out than coming in. You are entering the DANGER ZONE!!
*** Quick tip
Compare the cash reported under the operating activities on the statement of cash flows to your net income from the income statement. If the cash reported from operating activities is consistently more than the reported income, then the business is bringing in more cash than it is using. Which is a good thing!
Income statement
Also known as profit and loss statement, this is where the monthly reports get exciting! Or maybe that's just me. Either way, the income statement shows your revenue, expenses, and income with a breakdown of each.
Revenue - costs - expenses = net income. This is important. Remember this even if you remember nothing else.
Unlike the balance sheet, this report is for a specific time period. Generally, this will be for a month, quarter, or year.
It also provides key information regarding the profitability of your business. Depending on your industry, there may be significant changes in profitability from month to month. This can be incredibly important information for long-term planning as you may be able to determine a general pattern in your profitability through each year.
Understanding the monthly financial reports of your small business may seem like a daunting task. But if you spend some time getting to know them, they can be your greatest ally on your journey to achieve your goals.
Keeping tabs on the status of your business can determine whether your business fails or succeeds. Don't just think of bookkeeping as something the government requires of you for your taxes. Think of it as something that you give to yourself. You work hard on your business and you should utilize all the tools at your disposal to succeed!
Need help with your bookkeeping? Contact me here for a consultation.