Three Meaningful Business Financial Statements and Why They Matter
What do those words mean to you?
How do you feel when you hear them?
Excited, scared, nervous, confused?!
There are many facets to owning a business. Understanding the financial statements is a big part of them. Many business owners know of them, but not about them. Without knowing much about them, they ignore them, and that’s where things can start to get a little sticky.
If you’re not regularly reviewing your business financials, you’re missing out on essential and interesting details. Not to mention, neglecting the financials can have devastating effects on a struggling business.
Let’s dive in!
A Little Tip
First, if you’re unsure of the meaning of an accounting term here’s a little trick from me to you:
Stop overthinking it.
Look away from the words, reset, and look back. What do you see? If you’re looking at the Balance Sheet, then you know that this report is going to have something to do with numbers being in balance. We’ll dig deeper into that...
Let’s keep going!
So What Now?
The financials are here to tell you a story, not to intimidate or confuse you. Their job is to take all of the data you’ve put into your accounting software and give you the abridged version of all those numbers.
Your reports tell your story by answering three critical questions:
- How is my business doing overall?
- How is it doing now compared to this time last year?
- Is my business profitable?
Reviewing and taking action on your business’ story is an essential part of owning and growing a profitable company.
Through assessment and strategizing, you can turn a struggling business around. But, first, we must understand the reports....
The Three Most Meaningful Business Financial Statements
Now, let’s focus on the three most meaningful business financial statements. They are:
- The Profit and Loss - You’ll also see this statement called the P&L, the Income Statement, or the Net Income Statement. Its job is to summarize your company’s revenue, the costs associated with earning that revenue, and your operating expenses during a certain period.
- Your P&L starts with the “top line” aka your revenue, which is all the money you’ve earned from a single or multiple income streams.
- Next, is the cost of doing business also referred to as the Cost of Goods Sold. It’s the money you have to spend in order to earn that revenue. For example, if you’re a photographer, you may buy photo frames for clients purchasing print packages. This purchase is a cost of doing business because it's an expense you're taking on to earn revenue—and who doesn't love to see their beautiful photos in stunning frames!
- Finally, you have Operating Expenses. These are the day-to-day expenses that are an integral part of running your business. This may include rent, office supplies, advertising fees, utility payments etc. After deducting your Cost of Goods Sold and Operating Expenses from your Revenue, you have your Net Income, which can be a positive or a negative number. If it’s positive, your business is profitable! If it’s negative, you have a loss and will want to strategize to start gaining profitability.
- The Balance Sheet - Ah, the all-important Balance Sheet! And, yes, it must be in balance. If it’s not, we’ve got a problem! The Balance Sheet shows the company’s assets (what you own), liabilities (what you owe—debt), and equity (the company’s worth). The accounting equation represented in this sheet is Assets = Liabilities + Equity. This equation must always balance, hence the name. The Balance Sheet gives you a snapshot of what your company owns and owes, as well as what it’s worth at any point in time.
- The Cash Flow Statement (aka Statement of Cash Flows) - This report is the true underdog of the three. It’s typically overlooked, but it can also give you valuable insight into your company’s financial activity. Since “Cash Flow” is part of the report title, it’s pretty safe to assume this statement has everything to do with the money flowing in and out of your company. The main categories in this statement are the operating activities, investing activities, and financing activities.
Here’s why all three reports are meaningful and matter to your business
- The Profit and Loss is critical to review on a regular basis because it’s going to show you changes in accounts over a period of time. Changes are essential to keep an eye on! You may be making more revenue, but perhaps your expenses are growing at a faster rate. This increase will reduce your profit—even though you’re making more money! With this understanding, we’ll know that it’s time to cut some expenses and start making a profit.
- The Balance Sheet is another essential report because you want to know the value of your company and how that changes over time. You want to review assets, such as Accounts Receivables (ie, the money owed to you by your customers) as well as, liability balances (ie, Tax Liabilities or Loan amounts). Do you owe more than you own? Finally, take a look at equity to see the net value of the company. If it’s negative, then the amount of debt may be too high in relation to what the company owns. Another possible scenario is that company owners may be taking too much profit out of the company.
- The Cash Flow Statement is a must-review because it measures how well your company manages its cash. Pretty important, right? You want to review this report to compare money from operations to the net income on your company’s P&L. Doing so will help you understand how well your company is running its operations—the cash flow statement shows the actual amount of money the company receives from its profits. For a more in-depth dive into the Statement of Cash Flows, a colleague of mine breaks it all down beautifully: Check out the 9-minute video walk-through here.
The more business owners review and interact with their financial data—their story, the more successful they are!
How do you feel about your financial statements?
Are you finding them a bit more meaningful?
Do you ignore them because you’re not sure what it all means?
Reach out in the comments below with questions
or contact us for a free consultation!