ABC’s of Financial Statements Financials are a key to smooth sailing for small businesses.
By Lori Kravets
As a small business owner, do you really need a business plan? Does anyone ever read your financial projections? Can you run a successful business without the income statement, balance sheet and cash flow? Aren’t all those projections meaningless?
The answer is that you do need a business plan, and the financials may even be the only part of your plan that potential lenders and investors read closely. The financials also provide you with the most critical information you need to run your business profitably. Staying Balanced Managing your business without financials is much like trying to sail a ship without a hull, sails or rudder. The balance sheet is the hull and foundation for your business. Every company needs assets that continually earn a profit. These include items such as your building, equipment, vehicles, computers, accounts receivable, inventory and cash. The balance sheet tells you how you are financing these assets and what they are earning you as an owner.
For example, you might finance a new computer system through business earnings, a bank loan or a personal investment. The balance sheet clearly will show how much of the item the business owns and how much is financed. In addition, your decision to finance needs to be based on the idea that the computer either will earn you more additional sales than the finance charges or save you more in expenses than the finance charges. If it can’t earn or save you money, don’t buy it.
Finally, the balance sheet tracks your ongoing growth in wealth. The profit you earn each month is “closed” to the owner’s equity of the balance sheet, and the value of your business grows. Lenders and investors look at the balance sheet as a solid foundation of assets owned by your business and the ability of those assets to generate a profit.
Making a Statement The income statement provides the sail for your business ship. No customers, no sales, no business. The ship sits sinking in the water. The income statement (aka, profit and loss statement) documents your total sales each month—both cash and credit—and the exact expenses your business generated in creating the month’s sales.
Remember, your declared expenses must be in the same month as the sales, and a sale counts in a month only if the product or service is delivered to the customer. From a management perspective, the income statement tracks the cost of sales. It’s your opportunity as an owner to see if additional sales really will bring additional profit, or merely more expenses.
The income statement does not mirror your checking account. Many businesses continually generate healthy income statements with their tax returns but fail to generate enough cash to pay monthly bills. Remember that the credit sales are counted in monthly sales revenues on the income statement. These credit sales only become cash in the bank when the customer pays the invoice. Unfortunately, the customer payment may be 30 or 45 days behind the statement from your vendor for the product you sold.
The cash flow statement is often the statement ignored by business owners. This is unfortunate, because it has the best information for sailing your business profitably into the sunset.
The income statement may show, deceptively, the business as highly profitable with no money in the bank. On the other hand, a business should not have a continually positive cash flow and not be paying its bills. Simply put, the cash flow statement should tell the owner exactly where cash is coming from in the business and where cash is going. Only cash flowing through the business in a month will appear on the cash flow statement.
Sailing On For small business owners, their cash flow statements compared to their planned cash budgets provide the rudder to steer their businesses forward. A knowledge of where the business generated cash and where the business spent cash, along with aged accounts receivable yet to be received and aged payables in need of cash payment, keeps the ship moving smoothly through the water.
Entrepreneurs without strong accounting skills should feel comfortable seeking accountant referrals and talking frankly with an accountant. The balance sheet, income statement and cash flow provide the critical information needed to track the investment of your time and money in a small business. Such tracking leads to the ultimate goal of growing business profits, value and wealth.
Lori Kravets is the director of the Missouri Women’s Business Center, an organization that focuses on helping women create financially sound businesses. She can be reached at (816) 236-6142 or at .
