It will always be necessary to check your market and keep up with trends. Note that even the most popular television commercials change over time. With each new day you will find new challenges that your business must face and embrace. Therefore, take the time to regularly review all facets of your business.
There are three main reports your business needs to review monthly to understand the financial health of your organization:
• Balance sheet
• Profit and loss statement (also called the P&L statement or the income statement)
• Cash flow statement
Individually, each of these reports provides its own piece of information. However, none of the reports show a complete picture alone. For that you need to review all three reports, for the same dates. The profit and loss statement and the cash flow statement are generally run for a period of time, such as over a month or a quarter. However, the balance sheet is different as it is a “point in time” report. This means that the balance sheet shows a “snapshot” of one point in time.
To get an accurate view of your financials, you should use the last day of the period you chose for your profit and loss statement and the cash flow statement as the day you want to use to run your balance sheet. That will ensure that every charge in the profit and loss statement was taken into account in the balance sheet. For example, you may run one month as follows:
• Profit and loss statement: May 1 through May 31
• Cash flow statement: May 1 through May 31
• Balance sheet: as of May 31
As an entrepreneur, these three reports will help you keep your business on track. Any problems will show on these reports and the advance notice will allow you to make the course corrections necessary to stay competitive.
1. The Balance Sheet
The balance sheet has three parts: assets, liabilities, and owner’s equity. It is called a balance sheet because it is usually shown with assets in one section and liabilities and net worth in the other section. Both sections should balance. For example, if your business was to operate entirely in cash, and you withdrew any profits at the end of each period, the balance sheet would be very simple, showing $0 on both sides. However, most businesses don’t operate this way. Instead, they have ongoing assets and liabilities. Assets can include product inventory, ownership in buildings, business equipment, cash on hand, and accounts receivable (e.g., money owed to the business by customers). Liabilities may include things such as business loans, retained earnings (i.e., profits kept in the business and used to purchase more assets), owner equity, and accounts payable (i.e., money that the business owes others).
From this report, you can track how much money the business currently has on hand (i.e., your current cash position), what assets your business owns (i.e., tools and equipment), and what liabilities are outstanding. Although this report is valuable, alone, it doesn’t tell you if the business is making money or losing money. It also won’t tell you how much “cash” or money a business is spending each month. For that you will need the next two reports.
Sample 1: Balance Sheet
2. The Profit and Loss Statement
As mentioned earlier, the profit and loss statement is also known as an income statement or the P&L statement. This statement is usually run each month and shows a list of all the income (profits) and expenses (losses) for the business. This report will only list an item as an “expense” if the payment for the item went to pay a bill. If it paid down principle on a loan, the principle payment for the business will not be included in this report.
At the very bottom of the report is the total of all income and expenses. This number tells you if the business is making a profit or taking a loss. As a business owner, you can use this report to determine if your business is profitable or not. Review these numbers at least once a month to ensure that your business is performing as expected. As soon as you see any slippage, be prepared to start investigating the cause. If the profitability of your business is much less than you were expecting, chances are that your business has a problem that needs to be immediately addressed.
Most accounting programs also allow you to see this report by period (i.e., monthly or quarterly) over the course of a year or even a few years. Therefore, another benefit of this report is that it allows you to look at your business across a few months. From this information, you can see if the company is making more or less money than the previous period. Over time, this trend can tell how fast your business is growing. After you have a year or two of data, you can also identify any seasonal activity.
Now that you have both the profit and loss statement and the balance sheet, you can start to get a more complete financial picture. For instance, from the profit and loss statement it is easy to see that interest was paid; however, it is not possible to see what the current loan amount is. The balance sheet shows the loan amount as of the date of the balance sheet and the profit and loss statement will record that interest on the loan during the period reviewed.
Sample 2: Profit and Loss Statement
3. Cash Flow Statement
You need to watch the cash flow statement closely. The cash flow statement tells you how much cash (i.e., real money) comes in and how much goes out each month. It is possible for a business to make money (based on the profit and loss statement) and still have serious cash problems. The cash flow statement will identify if this is an issue for your company. For instance, your profit and loss statement will tell you how much money you make, but paying down loans, such as company vehicles, or purchase loans will not be included as an expense. Therefore, reviewing what your cash position looks like each month will help you prepare for purchases and other cash events.
Sample 3: Cash Flow Statement
After you have completed all three statements, they can be read together. In this case, you can see that even though the profit and loss statement says the business is making $3,500 per month, the cash flow analysis shows that there will only be an additional $500 in the cash account at the end of the month. From the cash flow statement, coupled with the profit and lost statement, it is easy to see where the extra $3,000 in “profit” is going:
• $11,000 in inventory purchases on the cash flow statement that were not included in cost of goods sold on the profit and loss statement
• $1,000 for the loan principle
• $1,000 for the owner’s draw
From this, the numbers seem more reasonable. In the last month, inventory has gone up, debt has gone down, and the owner took some money out of the business.
Lifesaver:
