Why Financial Statements Are Important for Entrepreneurs and Recommended Reading About Them
Why is it important to keep your financial statement in order?
Unless your an MBA, no one really teaches you how to do finances as an entrepreneur. You might have a book-keeper or accountant, maybe even a CFO, but they don’t always do a great job explaining how to interpret financial statements. Many early-stage entrepreneurs I know want to focus on everything — product, customer discovery, marketing, tech — except financial statements. In the early stage of a company, the financial systems might not be as important as generating positive cash flow.
However, once the business is self-sustaining, it’s important to get these financial systems set up. If you are looking to get a loan from a bank, an investment, or get acquired — all of these parties will look at your financial statements. Rather than taking their word for granted, you can do your own independent analysis and develop counter-offers as you negotiate.
More importantly, you should be looking at these documents on a regular basis to evaluate your own performance and calibrate your business accordingly. Your financial statements will tell you things like:
- How much money are you making as a business and how much it costs you to make that money
- Opportunities for cutting costs
- Identify customers that are paying late
- Financial irregularities
- How many days of runway you have left before you run out cash
- How profitable you are
Top Three Books for Entrepreneurs
As an entrepreneur, my top three recommendations for understanding business finances are:
1. “Managing By the Numbers: A Commonsense Guide to Understanding and Using Your Company’s Financials” By Chuck Kremer (Amazon Kindle)
This book has a super simple introduction to the three main financial statements: (1) profit / loss or income statement, (2) balance sheet, and (3) cash flow statement. The authors give a lot of examples from small businesses in both product and services companies to help you understand these statements.
In a nut shell, the profit / loss statement tells you revenue less costs = profit. Balance sheet tells you assets less liabilities = equity. The big shock for a lot of businesses is that they can be profitable but still die to issues with cash flow, which is where the cash flow statement comes in.
2. “Warren Buffett and the Interpretation of Financial Statements” By Mary Buffett and David Clark (Amazon Kindle)
This book teaches you how value investors evaluate the value of a business. It’s not enough to know the numbers, it’s how you use them to make business decisions that matters. While the book isn’t written by Warren Buffett (Mary Buffett is his ex-daughter-in-law), it gives a pretty good introduction to value investing.
Specifically, it teaches how you to look at financial statements like the balance sheet to evaluate a publicly traded company’s value over time. While this might not seem useful to a private company, it’s actually very useful. As opposed to a high-growth company which generates exponential user growth, attain network effects or a near monopoly through scale, and monetizing it through multiple revenue streams (data, ads, subscriptions, etc) — but fall just as quickly as they rise, value companies last the test of time and increase revenue while decreasing costs.
The book also has a great analysis of the interplay of markets and companies to help you understand how a business organism exists within a broader environment and no matter how valuable a company may look, certain markets tend to be highly volatile and unprofitable in the long-run.
3. Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports” by Howard M Schilit and Jeremy Perler (Amazon Kindle)
I met Dan Loeb founder of the hedge fund Third Point last year. I honestly didn’t know that much about him so after the meeting, I looked him up and found a list of books he recommends and Financial Shenanigans was on his list. After reading it, I realized why. It’s not only important to know what to do, but also what not to do when running a business.
The book is replete with story after story of how businesses engaged in financial improprieties and faced pretty severe consequences. From these case studies, the author extracts general principles on what to do and what not to do when managing a company’s finances.
Closing: What other books are out there that you recommend for entrepreneurs?