Learning to create the financial documents for your business is a worthwhile endeavor. Make yourself do it! You will gain a significant understanding of your business. You will learn the art of financial analysis.
Retaining a bookkeeper and accountant to produce the monthly statements and prepare the taxes is not enough. In most cases, they don’t know your business well enough to make important decisions. They can tell you when to cut expenses, but they lack the hands-on overview that effective decision making requires.
That responsibility (and privilege) is yours alone. Little by little, even those who may be intimidated by numbers can become comfortable with the process. Every business owner is the company CFO.
THE PROFIT & LOSS (INCOME) STATEMENT
This statement demonstrates whether or not the business is making money. It will be useful to generate a P & L statement every month, to chart your progress and help you pay attention to what the numbers are telling you. It is an excellent analytical and decision making tool.
Many entries from the Cash Flow statement will also be listed in the P & L: sales revenue generated from each product and service; variable selling expenses such as raw materials, labor, equipment rental and advertising; and fixed costs such as rent, office staff salaries and utilities. When you’re financially able to do so the owner’s draw, i.e. what you pay yourself, will be listed here as a fixed expense.
At the top of this statement, enter gross revenues (sales). There are also lines for beginning and ending inventory and cost of goods sold. Subtract COGS from gross revenues to reveal the gross profit.
Fixed and variable expenses are tallied and subtracted from gross profit earnings to give you the EBIT: earnings before interest and taxes. Loan interest payments and all taxes are then entered and subtracted also, to reveal in the bottom line of the statement the net profit or loss.
THE BALANCE SHEET
The Balance Sheet shows the financial picture of your business on a particular date. It demonstrates what the business owns and owes on a given date, usually at the end of the fiscal (or calendar) year.
The Balance Sheet is divided into 3 categories: Assets, Liabilities and Net Worth (owner’s equity). All business assets such as cash in the bank, equipment owned, inventory, property owned, office furniture and accounts receivable are considered assets and are entered in the plus column.
Business debts and obligations, e.g. loans and loan interest payments, accounts payable and taxes owed are entered into the minus column. Net worth emerges when liabilities are subtracted from assets.
THE QUARTERLY BUDGET REVIEW
The Pro Forma Cash Flow statement, which provides a projection of what cash can reasonably be expected to flow into and out of your business in a given month (or quarter), should be validated by a Quarterly Budget Review. Also called the Cash Flow Statement, this document gives the actual cash flow numbers for your business and is created after the fact.
Now you can compare your best guesses to reality. Are you over or under budget? What has been over- or underestimated? Do you need to trim or stagger certain expenses in order to pay the bills every month? How accurate were your sales projections? Moreover, how much are you spending to make the sale?
Needless to say it will benefit you to trim expenses wherever practical and control COGS by locating the lowest cost wholesalers and raw materials sources, to free up cash so you can comfortably pay the bills each month, pay down business debts and perhaps allocate money for useful promotional and advertising campaigns. You will also want to take that owner’s draw as soon as possible!
We’ll conclude the money portion next week with a look at what investors and lenders will also want to see.