No one starts a business because they love the paperwork and accounting that goes with it. All too often, those details are put aside in favor of the more interesting (and seemingly profitable) vision-casting, marketing, and sales. But knowing what your financial statements are and being able to read them can help you run your business more effectively and discover profit where you may not have realized any existed.
Balance sheet
The balance sheet is like a photograph, showing a snapshot of what your business’ current financial health is like. The most basic balance sheet compares assets on one side and liabilities on the other. If the assets are greater than the liabilities, the company has a positive net worth. If the liabilities are greater than the assets, the company has a negative net worth.
Assets include cash, receivables (because the assumption is that they will be collected), inventory, equipment (minus depreciation), intangible assets (like copyrights), and prepaid expenses. Liabilities include accounts payables, future income taxes, and long term debt. Your goal, of course, is to create a company that has more assets than liabilities.
Earnings statement (or income statement)
The income statement shows your income streaming in and your expenses streaming out over the year. The difference between income and expenses is your profit. As your business grows, this document will grow too. If you incorporate and have shareholders, you’ll need to add more sections to it. However, if you own a smaller company, a simple statement showing where the money came from and where it went is all that’s appropriate.
Your goal with this statement is to find ways to increase income and decrease expenses to improve profitability.
Cash flow statement
The balance statement shows your company’s financial situation at a given moment in time. The income statement shows your income and expenses over the course of a year. The cash flow statement is somewhere in between: it shows how the financial condition of the company changed over a period of time. It outlines the numbers at the end of the last period and at the end of this period so you can see the difference between the two. It includes such items as sales, earnings, asset value, and amortization amounts.
Your goal with this statement is to watch the numbers to ensure that they remain in line. It will help you see and plan for increases in (for example) receivables by ensuring that revenues match the increase.
All three of these statements are important to the small business owner who is serious about running a financially sound business. Like going to the doctor, these reports examine your business and allow you to make a diagnosis on your company’s health and future plans.
Now it’s time to create your own! Don’t worry about following the GAAP (Generally Accepted Accounting Principles) right now. Just try creating your own “thumbnail: financial statements to get the hang of it. Do this over a 6 month period and you’ll see a change in how you understand your business and the control you have over the financial aspects. In time, consider having an accountant create them for you.
