Whether you’re looking to get a line of credit, plan for tax payments, or simply identify strengths and weaknesses within your business, keeping clear and accurate records is vital for business owners to succeed.
But managing your company’s finances can be daunting, and there are many ways your financial reporting can get on the wrong track (just check out Dwayne Kolly’s recent post to see what not to do). To make sure your finances run as smoothly and accurately as possible, it helps to simplify.
There are three primary financial statements business owners need to focus on to ensure their companies operate effectively.
1. Cash Flow Statement
Although the concept of cash flow is relatively simple (cash coming in vs. cash going out), accurately measuring cash flow can be difficult for business owners. A survey conducted by cash flow expert, Philip Campbell, found that 82% of business owners said they did not feel like they had the cash flow of their business under control. As cash flow is essentially the lifeblood of a business, this is a troubling statistic.
One of the biggest challenges encountered by entrepreneurs and small business owners is that they’re forced to use tools that were designed with accountants — rather than business owners — in mind. But cash flow doesn’t have to be overly complicated. Preparing clean cash flow reports begins with being able to answer one question: What happened to the cash last month?
As Philip says, answering this question should only take you 10 minutes of work, and you should be able to explain that answer in a short, 2-minute conversation. To simplify this process, we recommend spending 10 minutes each month on a Cash Flow Focus Report (pictured below) to get your numbers in order.
After you’ve done this for a few months, you’ll be able to spend less time worrying about the state of your cash flow and more time making informed decisions for your business. You’ll also be able to more easily prepare an accurate cash flow statement for your banker. Here’s a Statement of Cash Flow template to get your started.
2. Balance Sheet
Balance sheets are snapshots of what you own (assets) at a particular point in time, and what you owe (liabilities). The difference between those two totals is what you have left (equity). They are another one of the most important financial reports business owners need to be approved for a line of credit.
But as Quickbooks expert Margie Monroe says, you shouldn’t only be preparing these documents for times when you have to present them. You can also use balance sheets to run your business. Having an accurate balance sheet is vital because it allows business owners to reliably evaluate their company’s profitability.
To quote Philip Campbell…
- Your gross margin is only as accurate as your inventory
- Your sales and bad debt expense are only as accurate as your net accounts receivable
- Your repairs and maintenance (and related expenses) are only as accurate as your property and equipment balances
- Your overall operating expenses are only as accurate as your accounts payable and accrued expenses
Though it may take some time, it’s valuable for business owners to fully understand their financial statements and become completely familiar with their balance sheet. If your business uses Quickbooks, check out this post for a step-by-step process to setting up your balance sheet. You can also a free balance sheet template here.
3. Income Statement
Income statements weigh a company’s revenue against its expenses to calculate profits. These statements can be prepared on a monthly, quarterly or annual basis to measure a company’s profits on a macro or micro level. The benefit of keeping accurate monthly income statements is that, over a period time, companies can evaluate where expenses can be reduced and identify potential opportunities to increase profit overall.
Income statements are created by first measuring total sales. To do this, cash-based businesses will simply add up the total cash received during that designated time period while accrual-based companies will recognize transactions once the goods have been delivered (regardless of whether or not they’ve been paid). Businesses that fall under the latter category would also include accounts receivable as revenue.
The next step is to calculate all of your business’s expenses. This means adding up all of the money spent by your business in order to produce revenue. That list of items includes: cost of goods, services general/administrative expenses, employee compensation and marketing efforts.
The final step is determining your company’s profit. There are a few different ways to do this…
- Gross Profit
- Operating Profit
- Net Income
Income statements play a key role in a company’s ability to evaluate the financial health, value and growth. When effectively executed, they can also be used for financial projection, estimation of project viability and goal setting. Check out this article to download a free Income Statement Template.
The income statement, balance sheet and cash flow statement are generally considered the most important documents for evaluating the financial state of a company. By keeping accurate records of each of these important documents, business owners can ensure they’re in control of their company’s finances and position themselves for approval when applying for a line of credit.