Financial Statements are key to understanding the financial health of your business. As an executive, I reviewed financial statements and managed budgets but I did it from a non-financial manager perspective, watching revenue numbers (income), expenses and net income. I worked at large companies that had great cash flow so I never had to think about that – especially since I didn’t work in finance.
I thought I had a good grasp on financial statements until I owned my own business. It was then, I realized how much I had to learn about financial statements. Honestly, I was surprised.
The first year I owned my business, my agency director called to ask me if she could pay some bills. I asked her if we had the money and she said “yes”. So I told her to go ahead and pay them. She asked me this a couple of times in a matter of weeks and I finally said, “what am I missing?”.
I couldn’t understand why she kept asking me that question. She explained to me we had the cash but our accounting person was really concerned about making payroll. We had enough cash to pay the bills. If other checks didn’t come in before payroll, we wouldn’t have cash to fund our employee’s checks.
The good news, we had a business line of credit we could draw from and plenty of invoices out to be paid. It was a timing thing. That was the first time I realized I needed to understand my numbers and specifically my financial statements better.
Learning about financial statements the hard way
Shortly, after that my accounting person had a life change and needed to transition the work she did to someone else. I had a choice to make, hire accounting help or learn it myself. Knowing I needed to understand my numbers better, I had her train me.
Like many small business owners, I ended up taking on the accounting side of the business. I was lucky I had a great teacher that helped me understand what I should be looking at. What I’ve learned since then is not everyone has that. Most of the time they don’t know they need it, or even what questions to ask.
By painstakingly paying bills, generating invoices, and closing the books each month, I learned the hard way. I got into the numbers to understand how the numbers worked together. Now that I have done that, I don’t need to do it again. Knowing how to read financial statements and what to look out for, and what my numbers are telling me has helped me make better strategic decisions.
Look at your financials monthly
If you have no idea where to start, start with the three financial statements every company needs. The three financial statements you should understand and review are:
- Profit and Loss (P&L) Statement sometimes called Income Statement
- Balance Sheet
- Cash Flow Statement
Financial Statement #1: Profit and Loss ( P&L) Statement or Income Statement
Profit and Loss (P&L) Statements, also known as an Income Statements, can be generated at any time, I recommend monthly. The P&L is a snapshot of your income and expenses at a specific time.
The reason I recommend reviewing them monthly, is it helps you understand how your business is doing.
Do you have seasonality in the business, are you spending more than you are earning, do you have a cash leak somewhere? Plus, if you stay on top of your financials monthly, it’ll force you to keep up with your invoicing and paying your bills which often gets pushed aside by entrepreneurs.
Financial Statement #2: The Balance Sheet
While P&L Statements give you an overview of what came in (income) and what went out (expenses), the Balance Sheet provides a snapshot of what a company owns and owes. The Balance Sheet shows your assets, liabilities and shareholders’ equity at a specific point in time
Think of it is this way, the Balance Sheet is the big picture – you have this much money and you owe this much money.
The P&L is what you got paid and what you paid. The financial statements work together. When you pay bills, you see it on the P&L at the point in time you paid it. On the Balance Sheet you will see the amount owed reduced by the amount you paid.
Financial Statement #3: Cash Flow Statements
In my situation we had cash – at a moment in time. When I was asked if we could pay a bill I shouldn’t have asked if we had money to pay it, I should have been looking at what else is coming due, when do we expect more payments, and what is the most critical thing to pay.
Think of it as the cash generated and the cash used during the statement period. Cash Flow is cash in minus cash out. (Cash Flow = Cash in – Cash out).
If you don’t have enough money coming in to cover the amount going out you have negative cash flow. More money coming in then going out is positive cash flow.
Cash Flow Statements are generated from numbers on the P&L Statement (Income Statement) and the Balance Sheet. You need the other to financial statements to create the Cash Flow Statement.