Every small business owner spends most of their waking hours fretting over the health of their company. Yet, not surprisingly, very few know how to make sense of the most powerful tools for assessing their company’s health – the Income Statement, Balance Sheet, and Cash Flow Statement.
This article provides a brief overview of each and how you can use them to grow your business.
The Income Statement
The income statement, also referred to as a profit and loss (P&L) statement, is very useful for providing a progress report of how well your business has done during a specific period of time. It breaks down the revenue generated and the costs incurred over a month, quarter, or year.
An income statement gives you a simple way to see where you are making money and where you are losing money. It can give you ideas about how to increase profitability by either investing more in high revenue generating activities or cutting costs. The income statement also tells you how much cash is left to pay your salary, reduce company debt, or reinvest in the business.
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The Balance Sheet
The balance sheet is a snapshot of the company’s financial position on any one day. It may seem overwhelming, but in it’s simplest form, it tells you what you own, what you owe, and what’s left over for you and your investors.
The balance sheet is normally issued at the end of a month or quarter—and lists the following:
- Assets – This includes cash (bank accounts), accounts receivable (what people owe you), inventory, capital assets (buildings, machines, vehicles), etc.
- Liabilities – This includes all debts like bank loans, accounts payable, outstanding credit card payments, etc.
- Owner’s Equity – How much of the business’s assets do you and your investors still own once you’ve paid off all your liabilities?
A balance sheet can seem a little overwhelming and the format can vary depending on your business type. But it’s also incredibly powerful for providing a glimpse into the following:
- Your company’s net value
- How much you are currently owed
- How much you owe
- Liquidity ratios (how readily you can turn an asset into cash, should you need it).
- By comparing balance sheets from period to period, you can see changes in your cash position, accounts payable/receivable, inventory, equity, and retained earnings.
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The Cash Flow Statement
Most businesses fail because they run out of cash and can’t pay the bills. Pay attention to your cash flow statement to avoid falling prey to such a fate.
As we all know, money doesn’t always come into your business at the same rate goes out! In fact, a business can be profitable yet still have cash flow problems. While your income statement can tell you whether you’re making a profit on paper, it doesn’t help you determine whether you actually have enough cash coming in to pay all your vendors, suppliers, and employees.
Your cash flow statement has three parts:
- Operational Costs – This includes your net income and losses, minus your regular expenses, and is the one number that you’ll want to see growth in because it provides an accurate picture of the cash you are generating before any costs associated with financing or investments are taken into consideration.
- Asset Investments – This section reports both inflows and outflows from purchases and sales of long-term business investments such as property, assets, equipment, and securities.
- Financing – This is the cash you’ve received as a result of a business loan, line of credit, the sale of stock, or other capital infusions.
In addition to helping you gauge whether your business has enough money to cover its day-to-day activities, pay its bills on time, and maintain a positive cash flow, your cash flow statement also informs a number of other financial decisions, such as whether you need additional capital to fund seasonal fluctuations or purchase inventory to support a growth in sales.
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The Power of Three
You have three main financial statements because they each tell you something a little different about your company. Depending on where you are in your company’s growth path, you may feel one is more important than the others for a period of time. But try not to fall into that trap. If you try to focus on using them together, in a holistic way, you will grow as a small business owner, and hopefully you will grow your business too!
And if you ever need any help making sense of your financials, don’t hesitate to contact your friends at Stride!