Are you an entrepreneur but hate the financials? Do you know the numbers are important but don't know why? Are you eager to hire someone to handle the books so you don't have to worry about it anymore? As an entrepreneur, you need to know and understand your financials but it is not as complicated as it seems. Furthermore, you are an entrepreneur, not an accountant; what you need to understand is how to make decisions based on your financial statements.
What is your Profit & Loss Statement telling you?
First of all, a profit and loss statement is the same thing as an income statement. They are designed to show how much money your business has earned and loss during a given time period using a summation of income and expenses. You can use this data to figure out which income stream to focus more attention on, what expenses need to be trimmed, and what it takes to improve the bottom line known as your net income. After paying attention to your P&L over time you can compare statements to determine the effect your actions have on the health of your business. For example, does spending money on advertising increase the desired revenue stream significantly? Does cutting a specific expense increase your margins or negatively impact your income? Understanding your P&L statement is understanding your business. You will be able to see dangers coming and tackle them before they become a crisis.
Understanding your Balance Sheet
The Balance Sheet helps you understand your company's assets, liabilities, and owner's equity at a given moment in time; basically a snapshot of how much your company owns and how much your company owes As an entrepreneur, while it is important to know how banks and private investors interpret balance sheets it is more important to know how to use your balance sheet to make decisions in your business. Should you take out a business loan? First, you must see how it affects your balance sheet. A loan will raise your debt and usually means leveraging your assets making your debt to equity ratio high and risky. If your company's debt to equity remaining high for too long you risk losing your assets and possibly your company. If you can use the loan to increase your assets and operating income which pay off the loan and interest payments then it may it more the risk for your business. Another point of interest with your balance sheet is your working capital. Working Captial simply is your ability to pay short term debts with assets that can be liquidated within a year. Without working captial, a company may not be able to pay debtors or grow the business. When making decisions in your business pay attention to how that decision will affect your balance sheet.
Analyzing your Cash Flow Statement
The Cash Flow Statement is simply a report who how cash gets generated and used. It is separated into three categories; operating, investing, and financing cash. Financing cash is money raised from banks or investors as well as cash paid to shareholders. Investing cash is money used to buy or sell assets which can include buildings and equipment. Most important to entrepreneurs is operating income which is cash generated from business activities. If your product and services aren't making enough profit to move the business forward then it is inevitable that your business will fail. In fact, the first reason to take on investing or financing cash should be to increase operating cash. As your business grows it should, of course, buy more and more assets but never take your focus off of the operating income of your business because it is the first indicator of the health of your business.
You may not be an accountant, but you need to know who to understand financials including your income statement, balance sheet, and cash flow statement. Understanding your financials requires ongoing study and consultation. You the business owner so you don't need a finance degree, you just need to know how to make decisions based on your financial reports.
What do you think? Do you know your numbers? Do you have a clear understanding of your financials? Does this information help you?
- Murphy, C. B. (2019, April 07). What Is a Cash Flow Statement? Retrieved from https://www.investopedia.com/investing/what-is-a-cash-flow-statement/
- Robbins, Tony. “The Power of Financial & Legal Analysis.” Business Mastery Conference, Aug. 2016, Las Vegas.
- Staff, I. (2019, March 12). Reading the Balance Sheet. Retrieved from https://www.investopedia.com/articles/04/031004.asp
- Profit and Loss Statement - Guide to Understanding a Company's P&L. (n.d.). Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/accounting/profit-and-loss-statement-pl/