Demystifying Financial Statements.

Demystifying Financial Statements

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You’ve made the leap. Taken your life into your own hands and started your own business. You’re passionate about it. You’ve got a couple of employees who are putting out some really astounding efforts, and it’s time to look toward the future. That’s when it hits you… the horror stories you’ve seen and heard about companies plateauing or failing.  Perhaps because the operator, like the mythical Icarus, got too close to the sun and missed some minute financial detail that started them on the path to failure. But that’s not you, you’ve got a handle on this … right?

But how do you make sure your business doesn’t head down the path to becoming a statistic? Much like a car, your business responds to the inputs it receives, and requires regular maintenance and diagnostics to stay healthy. So, what’s the equivalent of a 100-point inspection for your business? Financial statements.

It’s accrual world.

Regular, accurate financial statements are the best and easiest way to get an idea about the health of your business. They give you the information you need to determine the key points: Is my business profitable? What does it cost me to keep the business running? Do I have enough cash in the bank to pay the bills? Do I owe anyone? Does anyone owe me? Can I grow my team? These questions can be answered by a solid understanding of regular, timely, and accurate financial statements.

Financial statements typically come in three standard parts: an income statement, a balance sheet, and a cashflow statement with actuals, all of which should tie back to your budgets.

You have a budget, right? One that you didn’t write a year ago, and you’re hoping still applies to what you’re doing?

Income statement

The first piece of your financial statement, the income statement (sometimes called P&L or profit and loss report) is a listing of revenues and expenses that have flowed through the business in a given period. This is where having detailed books plays the most important part. It’s great to have a line on your income statement called “Revenue”, but that doesn’t tell you very much about the key performance indicators of your business. In the example that your company sells a physical product, as well as support and maintenance packages for that product, it is much more beneficial to have those income streams represented on separate lines.

Do we spend too much money on salaries for support staff relative to the money we’re bringing in for support-based revenue?

Do we need a larger sales force to boost the sale of physical products?

The same is true for outflows from the business. What are the costs of operating and maintaining our facilities?

What does it cost to produce a single unit of our product? The net result of the income statement is a key indicator to how the company is performing in the given time frame.

Balance Sheet

The balance sheet is the counter-point to the income statement. It represents the business’ current financial position by breaking down the assets and liabilities held by the business at a specific point in time. The balance sheet will come in 3 parts: assets, liabilities, and equities.

  • Assets represent anything of value the company owns: bank accounts, equipment, inventory, vehicles, property, receivables, and more.
  • Liabilities represent anything the company owes: loans, credit cards, payables, taxes, and more.
  • Equities represent the investments that have been made into the business by shareholders, as well as any earnings the business has which have not yet been invested or distributed.

Cash flow statement

Arguably the most important piece of the financial statements for companies looking at growth and expansion, the cashflow forecast is a real-time look at the money coming in and out of the business, when it is expected to do so, and where it’s headed. It lays out the payables by due-date, accounts for regular expenses (payroll, rent, etc.) and brings in the expected receivables to give you the best idea of what your business will need in the coming weeks and months.

Um… so… about our books…

When your business first started, like many businesses before you, the finances weren’t the major concern. You were busy developing a product, masterminding a marketing strategy, and driving sales as hard as you could. All the bills and invoices went into a box that was tucked away under the desk that surely someone will go through one day. That box has grown into a series of nightmares that no one wants to look at. But now you need financial reports to take to your bank to secure the credit you need to expand.

Box time.

It may take time and resources, but sorting through the nightmare and getting all that data inputted into a real accounting system (not just a spreadsheet) is the best way to move forward.  Your financial advisors will be able to propose several solutions for you to get your books up to date.

This is usually the point where you hire a bookkeeper, or start looking at outsourcing finances to a third party. That third-party will often be able to lend you an expert second opinion on the current state of the business and what you need to do moving forward.

An accountant is someone who solves a problem you didn’t know you had in a way you don’t understand.

So now what?

To really stay on top of your business’ financial needs, read through your financial statements every month. Don’t forget about the updated budgets. By reading updated statements frequently, you’re less likely to;

  • overlook an upcoming payment,
  • and more likely to catch that delinquent receivable that you’ve forgotten about.
  • Finally, you’ll be less likely to be caught by surprise when you see the number at the bottom of your bank statement.

Your monthly financial statements should be produced by your in-house bookkeeper, or your out-sourced accountant.

Once a year, your accounting firm of record will look over your books and point out any discrepancies or inconsistencies in your books before you close them on another successful year.  This will give you a chance to take a larger-scope look at your business’ health and viability.

Show me the money.

Aside from getting a handle on the financial state of your business, financial statements serve a practical purpose – attracting credit and investment. Your ability to secure credit and investment is directly tied to the accuracy of your financial reporting.

The reality is investors are looking to make their money grow, grow quickly, and always have an eye on the door. Investors are looking for businesses with clear paths to growth, profit, and exit-strategy.   Having good financial statements is the best way to be appealing to a potential investor.

As such a business that is already doing a steady, is a much more attractive proposition to investors than one that is looking for money to cover its next payroll cycle.

Banks and creditors operate on a similar basis.

Just do you.

Even if you’re not actively seeking investment, your financial statements are the lifeblood of your business. They will help you maintain a healthy cash balance in your business, and prevent you from falling into the trap of becoming asset-rich, cash-poor. This is a problem that plagues small businesses.  Where every penny of income is invested back into growing the business without first making sure that the company can cover its expenses for the next cycle.

Having that shiny new piece of equipment isn’t going to do much to help you grow if you don’t have enough cash on hand to pay someone to operate it. Balancing your investment in expansion with operational security is one of the keys to staying profitable for as long as possible. Your financial statements are the guiding light to growing your business sustainably.  And they let you get back to the parts of your business you’re most passionate about.

The next step

  1. Get your financials in order. Find someone who can help you do this (click on the top left corner of the page, because you’re already here)
  2. Get more money. Or don’t… your call, really. Just don’t wait until you need more money to build a set of financials.
  3. Get back to work.
  4. Ponder the mysteries of life: would a giraffe wear a neck tie at the top or bottom of its neck?

Your financial statements. Get them. Read them. Learn to love them.

It’s your money, after all.

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