UNLOCKING THE TOP 3 FINANCIAL REPORTS: WHAT THEY TELL YOU AND WHY IT MATTERS.
We know not everyone geeks out over the power of financial reports.
As a business owner, you’re up against a million demands on your time and often this means that focusing on financial reports is just not your priority.
As hard as it can feel to carve out time each month to sit down and look at your numbers, we’re here to encourage you to make this a non-negotiable. Just like you pay your electricity bill each month because you know you need to keep the lights on, you also must spend time understanding your numbers to shed light on how your business is performing.
As they say, you can’t manage what you don’t measure. And this is where financial reports come in.
Whether you use a cloud-based accounting software (we recommend Quickbooks) or track your finances using spreadsheets, if you look at our top three financial reports monthly, quarterly, and yearly, your business awareness will grow exponentially. Instead of feeling frustrated and confused by your numbers, these reports will help you understand how each financial piece of your business fits together.
And what happens then? You’ll gain confidence, you’ll gain perspective, and you will feel in control of the financial decisions ahead of you.
We’ve seen time and time again, that when business owners are engaged with their finances, they create more sustainable, fulfilling and authentic businesses. And we want this sense of satisfaction for you!
So, let’s get into the details of how to measure what matters...
Part 1 - Interpreting your Income Statement
First things first, and this is essential, if you want to be able to track your business’ performance you need to have a good record of your business’ income (sales/money-in) and expenses (money out) each month. You can do this in a simple spreadsheet when you’re just starting out, but we recommend graduating to a cloud-based accounting software like Quickbooks, as soon as possible. You’ll save tons of time using software automation, especially when it comes to pulling financial reports.
So from here on in, we’re going to assume you’re being diligent and tracking your business’ income and expenses with whatever method you pick.
If you do this in a spreadsheet, you’ll need to summarize the info so you know your total income, total expenses, and the resulting net income or profit each month.
Net Income = Income - Expenses
If you use an accounting software, this process is automated as long as you’ve entered that month’s transactions.
Ok, so now onto how to read your Income Statement:
Think of your Income Statement like a movie that follows the plot of money in and out of your business over a period of time.
Last month’s movie might look something like... your business made 10K in sales, spent 2K on inventory purchases, spent another 5K in operating expenses, and ended the month with 3K in profit. (10K income - 7K total expenses = 3K profit)
But why is this so important?
While there are many different business models out there, all businesses must break-even or make more money than they spend to be self-sustaining.
And this brings us to how to interpret what you read...
When you review your Income Statement regularly, you’ll come to see the trends in your business.
Do you make a profit most months or are you often spending more than you make? Do you notice that each year there are certain months where you have to spend more than you make in order to be prepared for peak months? If so, take note of this.
Read the patterns of your Income Statement like a detective would looking for clues.
How does this month or this year compare to the last one and what do the numbers tell you about the direction of your business?
If your income is growing, but your expenses are also increasing exponentially to drive those sales, it’s important to pause and consider whether you’re running your business sustainably.
Cash flow challenges are one of the most common reasons businesses don’t survive, so stay aware of how often in the year your business spends more than it makes.
Another tip is to think in percentages as you review both income and expenses. This helps put things in perspective and gives you a framework you can apply as you grow.
If you have multiple sales channels, consider the percent each makes up of your total sales. Is the channel that makes the most money for your business also your top priority? Are you spending lots of time working on a part of your business that brings in little sales? Consider investing more of your time on the channels ripe for growth.
Now look at each of your expense categories as a percent of your total income. What are your top expense categories by percent of total income (ie. Marketing Expense / Total Income)? Are there certain expense categories where you may be spending too much as a percent of your income? The good thing about thinking in percentages, is when you determine a comfortable percent of sales for marketing, for example, you can apply this whether you’re making 5K p/month or 20K.
Using your income statement to plan your budget…
Creating and using a budget to keep your business on track is essential.
When it comes to planning your budget, last year’s Income Statement is the ideal place to start. Plan your income top down and bottom up. You can apply a growth rate to last year’s income to begin, but then realistically consider what it will take to make those sales happen and detail this out as a sanity check.
It’s also smart to organize your budget in the same format as your income statement, so you can easily compare your budget to your actual numbers throughout the year.
Part 2: Interpreting your Balance Sheet
If the Income Statement is a movie, think of your Balance Sheet as a snapshot.
The Balance Sheet captures the value of your company on a particular day.
Without getting too accounting focused, the Balance Sheet is a representation of the accounting equation, which says that Asset = Liabilities + Equity.
Assets are what your business owns. Things like the value of your bank accounts and fixed assets like computers, vehicles, or real estate.
Liabilities are what your business owes. Things like bills, credit card balances, lines of credit and so on.
Equity is the value left over when you deduct your liabilities from your assets.
Part 3: Interpreting your Cash Flow Statement
And last, but not least, the Cash Flow Statement, which you can think of as a movie because it covers a period of time.
This Cash Flow Statement answers the question: Where did my cash come from & where did it go?
Reading the Cash Flow Statement:
This report starts with the operating activities that impacted your business’ cash during the period you’re reviewing.
Your Net Income is first up (Income - Expenses).
Then any financing activities that impacted your business’ available cash, like distributions to owners or draws from a line of credit.
Then comes the net cash change for the period. This is the increase or decrease in the business’ cash during the period you’re reviewing.
The bottom two lines of the report show the cash you had at the beginning of the period (ie. on Oct 31st if your report covers Nov 1-30). And then your cash at the end of the period, which is your beginning cash less the net increase or decrease during that period.
But how should I think about this info?
It’s so common for business owners to feel confused about where their cash goes each month. This report is the answer in black and white terms.
If your net income is negative a few months in a row, you’ll see your cash dipping and know why. Perhaps you’ve been drawing too much money for yourself out of the business - oh, well that’s there too. Take stock in this report as a litmus test for whether your cash is working for you or you are just working and churning through available cash.
During growth periods, cash can be very tight because your business is spending money to make more money by expanding its products, services, and building out its operations. When you’re growing, its key to manage your cash carefully. You want to make sure you spend your cash in ways that contribute to your bottom line.