Business reports are not the most exciting or glorious topic, but creating and understanding your financials through three standard business reports, and how they work together, is vital to your business’s success. They can help you make critical business decisions that may determine whether your doors stay open or close. Understanding your company’s numbers will help you make smart decisions about your business, such as whether you should spend more on advertising, when to invest in new equipment, or when to cut back on inventory. You cannot make correct decisions by only looking at your bank account. You need to look at your overall financials.
The three vital financial statements that every business should run regularly are:
- Profit and Loss (or Income) Statement
- Balance Sheet
- Cash Flow Statement
Individually, each report gives you a partial picture of your company’s financial health, but together, these reports can help you understand your company’s overall health.
First, the Profit and Loss (P&L) statement, it is like a moving picture – showing what has happened to your business over a period of time, all of its ups and downs. A P&L statement is most helpful run regularly (usually monthly) with annual totals. Over multiple years you can spot trends in your business (are some months consistently better than others?), which allows for smarter business decisions. Companies commonly compare the current year’s activity with last years (LY) and the year before last (LLY), looking for trends, and to see if the business is doing better in a similar time frame.
Basically, a Profit and Loss Statement takes the total of your sales and subtracts the Cost of Goods Sold (COGS) for your gross income. It then subtracts your business operating expenses, taking into account such things as interest and taxes. The amount remaining is your net profit (or loss).
If a Profit and Loss statement is like a moving picture, then a Balance Sheet is more like a snapshot. It gives you a glimpse of your business at any given moment, what your business is worth if you were to close your doors. A Balance Sheet is usually done at the close of an accounting period and shows your equity. Put simply, it is the total of all your assets (i.e. car, property, land) minus your liabilities (credit cards, loans, etc.). The result is the net worth of your business. Some company closures are due to a company’s liabilities being higher than its assets, resulting in negative equity value.
Though when it comes to business failures, about one third are due to lack of cash flow. This can often be avoided if you understand the flow of cash in and out of your company, so that is where the Cash Flow Statement comes into play. This is basically your budget, it looks at your monetary needs for a period of time.
Think of it as a marriage between your Income Statement and your Balance Sheet. Both the Income Statement and the Balance Sheet provide good information, but neither alone gives you the whole picture. Your cash flow report brings everything together.
The P&L statement shows your operating income and expenses, but not your assets (investments) and liabilities (loan payments), those are reflected on your Balance Sheet. The Cash Flow Statement lets you truly know where your business stands when it comes to cash (Cash is king – you cannot survive without it!). It will show the amount of cash you have on hand at the beginning of a period of time (i.e. – month), then add in your income from sales and services, as well as any investment income, then subtract all your operating expenses and liability (loan) payments. This results in the amount of cash remaining at the end of the month. It reflects ALL cash that flows in and out of your business.
A business may appear to be doing great because of high sales, but go bankrupt because their expenses and liabilities are so high, they just don’t have enough cash to operate on a regular basis. If the owners just look at an Income Statement or Balance Sheet, this problem may not be obvious, but when brought together in the Cash Flow Statement, problems can be spotted early and hopefully rectified before a business is ruined.
If you do not fully understand your company’s financials, do not feel overwhelmed by all the different business reports. Just start with these three vital reports: Profit and Loss Statement, Balance Sheet, and the Cash Flow Statement. Once you get into the habit of running these reports regularly, and understand them, then you can consider branching into other reports that may also offer valuable insight into your business.