by Michael Lodge
So many times I sit down with clients that own businesses and they have no idea where their company stands financially. They only judge their company by how much they have in their company bank account for that day. No one has explained to them how to read their financial statement and to use it as a score card on what you are doing, what you have done and how to use the financial statement to plan our the future. But instead they sit there in my office and tell me how much money they have in the bank and their approximate expenses. So I encourage each of you that own a business – know your business, learn the importance of understanding your financial strengths and weaknesses. It is not all about cash – it is about managing your business.
Many business owners don’t know how to read their statements and rely on advisers (such as us accountants) to tell them the results. Their input is valuable but you need to educate yourself. You must be able to understand your statements so you can:
- realize the vital role money plays in every business decision
- determine if you are making a profit or losing money
- calculate your current and future financial needs
So what are we looking at, what are these statements? Financial statements are meaningful, written records which allow you to diagnose your financial strengths and weaknesses and increase the life and profitability of your company. Statements are usually prepared annually although the income statement should be developed on a monthly basis. That is why you hire an accountant each month to prepare a financial statement.
What do the statements show?
- Balance Sheet – what your company owns, what it owes, and what is left over
- Income Statement – a firm’s sales and expenses plus its profit (or loss)
- Ratios – analyze a company’s financial condition. Ratio answers can be compared to others in the same industry.
- Cash Flow Statement – the sources, uses, and balance of cash, shown on a monthly basis.
What Does A Balance Sheet Tall Us?
This statement shows what you own (assets), what you owe (liabilities), and what’s left over (net value or equity in the business). The numbers change every time you receive money or give credit to a client as well as when you pay for or charge an expense.
- Liabilities + Net Worth = Assets – Think of the Balance Sheet like a scale. Assets and Liabilities alone are out of balance until you add capital, the last weight put on the scale, to make it balance.
- Assets – Assets are divided into two categories: current and non-current. They are listed according to how liquid they are (how quickly they can be turned into cash). Examples of current assets are cash and inventory. Examples of non-current assets are furniture, fixtures, property and equipment. Money owed to your company (accounts receivable) is considered an asset.
- Liabilities – Liabilities (debts you owe) are divided into two categories: current and non-current (or long-term). They are listed in the order they need to be repaid.
- Capital or Net Worth – The business equity includes money the owners have invested and income kept in the business from the company’s profits.
What does the balance sheet show you?
- The net value of your business
- How much of your loan debt is current, and how much is long-term
- Percentages and ratios (which are extracted from the numbers) necessary to analyze your business
- Compare two of the same time periods to see changes in: >cash > accounts payable > accounts receivable >equity > inventory > retained earnings.
What Does The Income Statement Tell You?
In the day-to-day running of your business, numbers fly around at a dizzying pace. Bills are paid, money is taken in, and sometimes, in the whirlwind of activity, it’s hard to know how much you’re actually making. The Income Statement answers these questions.
Think of the Income Statement as a kind of report card for your business. Like a report card, it is issued from time to time and gives an overview of how you are doing (for that period of time).
Since this statement reflects your business activity over time (not like the Balance Sheet which is a snapshot of your business for one moment in time), it is usually developed monthly, quarterly and annually. Creating a projected statement for the next 12 months, based on your predictions, is also a good idea.
What It Shows You.
- If sales are going up or down
- Your gross profit – how much money is left for the rest of the business after deducting what it costs to produce or purchase the product
- All expenses for the time period it covers
- Increases and decreases in net income
- How much money is left to grow the business
- How much money is left for the owner(s)
- How much money is left to pay debt (principal only)
What Does A Cash Flow Statement Tell You?
Cash is the fuel that runs your business. Running out of it would be disastrous, so you must have a “cash flow” or money on hand to pay bills, and meet day-to-day expenses. Keep in mind that companies can produce a profit, but still not have a positive cash flow.
The Cash Flow Statements shows money that comes into the business, money that goes out and money that is kept on hand to meet daily expenses and emergencies.
What the Statements of Cash Flow Shows You.
- If the business has enough money to: 1) cover day-to-day activities, 2) pay debts on time, 3) maintain and grow the business without a negative cash flow
- The need for additional working capital (cash) when sales increase since increased sales mean increased purchases of material or labor. you should know how much you need. Show where the additional working capital will come from.
- The maximum loan payment the business can afford
- The breakdown of principal and interest on your loan payments. Note that the Income Statement only shows interest – not principal.
- Your weaknesses (an inability to keep and generate cash). For lending purposes, explain how you will handle these weaknesses (via increased sales, cost reductions, or owner’s investments).
If you can understand these thee reports you will be a step ahead of the game. You need to really know how your business is performing. Learning to read financial statements helps you plan for the future and know what you need to do to improve and grow your business.
Sit down with your accountant and ask to go over your financial statements, monthly or quarterly. Take control and know your business.
If you have any questions on financial statements send an email to: firstname.lastname@example.org