Understanding Financial Forms

Part four of five

This is part four of our “Understanding Your Financials” Series. We began with an introductory post, went on to specifics about Sales and Marketing numbers, then a post on financials for Operations.

Today’s focus is Financial Forms.

The “Big Three” financial forms are the Cash Flow Statement, Balance Sheet, and Income Statements. Your accounting software generates them with ease. But what do they mean, and how do you, the business owner, read them?

The Cash Flow Statement, in a nutshell, shows you how your most valuable asset (cash) flows in and out of your business at any given point, so you will always know how much cash you have on hand to pay current and future expenses. This report summarizes how much cash was received, how much was paid-out from your checking account registers, your credit card statements, and how the receipt of cash and payments of cash has affected the balance of all your other accounts. A business that does not protect its cash flow may find itself without adequate capital to buy inventory or pay employees.

The Balance Sheet concisely reports a summary of the assets, liabilities, and the net worth (owners’ equity) of your company at a specific point in time. Assets are goods (items of value) owned by your company: cash, inventory, equipment, real estate, intellectual property, and money owned to you by others (accounts receivable). Liabilities are obligations that you owe to suppliers: loans, taxes, and outstanding invoices (accounts payable). Owner’s Equity is your sweat, tears, cash you invested in your company, and whether your Equity has been increased by accumulated net profits or decreased by accumulated net losses. Assets minus Liabilities equals Owner’s Equity is not only the basis of your balance sheet information it is the basic method for recording all business transactions in terms of their effect on the various accounts.

You should at least be aware that the equation is assets (minus) liabilities = owners equity.

The Income Statement (aka Profit & Loss Statement) is a snapshot covering a period such as a month or a year (divided into months), summarizing your revenues (sales), less your expenses, and shows you whether you have made a profit, suffered a loss, or broken even. Your Income Statement should be compared to your monthly budgets every month, so you can gauge if you are reaching your sales goals, controlling your expenses, and earning your projected yearly profits.
Expenses on the Income Statement are divided into categories which give you an understanding of how and when your assets are being used in creating products and services and generating sales. Variable expenses (Cost of Goods Sold) are listed first under total revenues. This expense category must include all costs to produce services and inventory, such as materials, labor, shipping costs, etc. The next category is General Administration, which includes all the other costs that you incur to run your business monthly, such as rent, accounting, interest payments, legal fees, capital improvements, utilities, insurance, monthly management, and staff salaries, etc.
What can be confusing is that there can be payroll expenses in each category. It is important that you or your staff should be placed in the category most appropriate for their activity. For example, if you spend 50% of your time producing inventory or delivering services, and 50% as a manager writing sales proposals, your salary should be split 50/50 in the accounts. However, don’t overdo it, be logical, you’ll be under stress if you start tracking 5% here and 15% there.

BEFORE YOU GO:

We see our blogs as opportunities for dialogue. Please share your thoughts as comments.

  1. What do your financial statements tell you about your business?
  2. How do you use financial statements in managing your business?
  3. What is the most confusing part for you?
  4. What advice do you have for new entrepreneurs?

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Faris Alami is Founder and CEO of International Strategic Management, Inc. (ISM). He works internationally, presenting Exploring Entrepreneurship Workshops and other entrepreneurial ecosystem — related ventures.