Financial Statements Demystified
- Learn why you should pay attention to your financial data
- Discover how the “Big 3” financial statements can benefit your business
- Learn how each statement offers a unique perspective on your business
When it comes to the choices that affect your business’s future, don’t look toward fortune tellers or horoscopes. The knowledge and data to help you grow your business is contained in three documents many small business owners overlook. In this post, we want to show you why you should play closer attention to the Big 3 financial statements:
- The Balance Sheet,
- The Income Statement,
- and the Cash Flow Statement
I can hear all the small business owners out there saying “I just looked at a balance sheet for my business 2 months ago” or “I fired up QuickBooks last week to check how much cash I had on hand.” Give yourself a pat on the back…but then ask yourself how often you review these statements and make changes based on that review?
The balance sheet, income statement, and cash flow statement help you diagnose the financial health of your business. To unlock their power, you need to make these statements part of your everyday life and review them consistently.
Think about it like this. Let’s say you plan to run a marathon or any other major physical feat that requires you to train consistently. A marathon is a big goal to shoot for, especially if the starting point for your training is the living room couch. To make sure you’re on track to meet these goals you’d probably want to track your pace or your heart rate or monitor your calories. Doing this would give you the information you need to make sure you’re progressing toward your goal.
Well, business owners have goals too, like expanding your business, or buying new equipment, or even cutting costs. Your financial statements give you the data you need to make sure you can meet your goals and have a sustainable business.
Before tackling any of those business goals, you’d probably want to know the current condition of your business, right? Like what your business owns and what it owes, or its assets and liabilities. That’s what the balance sheet can tell you.
Let’s say you own a bakery. In that case, your assets would include things like inventory, or the ingredients you use to make your delicious baked goods. Equipment like ovens or baking racks are also assets.So is money owed to you by customers or other businesses.
The balance sheet also helps you keep track of your liabilities, or what you owe to others. Common examples of liabilities include debts or interest payable to others, such as a bank; rent, tax, or other costs involved in running your business; as well as wages paid to your employees.
While knowing your business’s assets and liabilities may seem like a fairly ordinary thing, here’s an example of what that information can show you. Using information about your assets and liabilities, you can calculate your business’s short-term financial health. Do you owe more than you own at the end of the last three quarters? If your answer to this is “yes,” you may have difficulty meeting your current obligations.
If the opposite is true and your balance sheet regularly shows that you own more than you owe, you’ll have more cash on hand to think long-term about your business.
The Income Statement
Let’s face it, you got into business to make money and pave the road to a better future for you and your loved ones. The income statement, as the name implies, shows you how much income your business is generating on a regular basis.
It’s hard not to get excited about income, or revenue. After all, income is money flowing into your business as a result of your investment of time and effort. Simply put, “income” on an income statement reflects the money your business receives from the goods and services it sells.
Income is great and all businesses want to generate it but that income comes at a price and that price is the cost of the goods sold. After all, you may sell a bunch of tennis racquets, or widgets, or cupcakes, but it costs money to make those sales. Your business needed to buy inventory and invest time and labor before you could sell anything to customers.
Using the data on an income statement you can also calculate your gross profit margin. Gross profit margin is the difference between income, or revenue, and the cost of goods sold. Reviewing the gross profit margin over time can show you if you’re pricing your goods and services appropriately and whether you need to make adjustments.
The income statement also gives you a key piece of information; namely, if your business has made a profit or is operating at a loss. You’ll want to pay attention to whether your business has made a profit or incurred any losses but remember to put that figure into context.
Are you a new business? In that case, keep in mind that many businesses operate at a loss before they become profitable. Is your business consistently operating at a loss? Consult a financial professional as well as your team to discuss possible adjustments to how you do business.
The Cash Flow Statement
Cash is king for a small business and, if we’re being honest, it’s probably also the queen, prince, princess, and entire royal family. Having cash on hand helps you make thing happen for your business. Monitoring the flow of cash into and out of your business is critical. Knowing your cash flow helps you to see how much cash is coming into your business, how much is going out, and from what activities. Consider cash flow need-to-know information for your business.
Many business owners live in the moment. They run their businesses well and treat every customer like royalty. More often than not, they either don’t have the time to pay close attention to their numbers on a weekly or even monthly basis. However, getting in the habit of reviewing your numbers closely can help you look to the future while also living in the present.
When you’re ready for a deeper dive into financial statements, check out our post on the importance of a small business budget.