When an entrepreneur starts a business, it's like heading out on a long road trip. You'll be going through all kinds of weather and roadways. To avoid extreme weather and rough roads, you need a map to help guide you. In your business, your financial statements are the roadmap for your business's road trip.
Financial statements are active records of your business
They show the activities (the ins and outs of your money)
They let you know how your business is doing
The financial records of your business can be viewed at any time. The statement will depend on the data you are looking at. The data may be as of that moment for all time, it may be for the week, the month or the year (you can specify on some reports). Based on these records you can tell how your business is doing.
To know how your business is doing we need to view one of three, and then all three, financial statements.
For additional accounting definitions and helpful bookkeeping info, check out the free Entrepreneur's Guide to Bookkeeping.
Let's break these statements down and see how they work together.
The balance sheet tells you how much money your business has at that moment in cash (assets), how much it owes (liabilities), and how much it's worth (equity). When you run a balance sheet the information is as of that moment, which differs from the income statement.
Most entrepreneurs use an accounting method called "cash basis". This means that your balance sheet will only show your bank balances. You won't have accounts receivable (money owed to you) or accounts payable (money you owe someone). It's very straight forward.
Each statement has its own formula. For the balance sheet it's:
Assets - Liabilities = Owners Equity (how much you own)
Let's break it down:
Here is an example of a cash basis balance sheet.
The balance sheet is important, (although it doesn't get as much love as the income statement) because it shows you how much money you actually have! DON'T ignore the balance sheet, it has good info in it! It shows you how much money you have!
The Income Statement
The income statement, also known as the profit and loss or P&L, is most people's favorite statement. This one shows you how much money you made, and we all love that don't we? It also shows you how much money you spent.
The income statement formula is:
Sales - Expenses = Net Income
Let's break it down:
Sales are all the revenue you earned from all your services, products, and affiliates. It can't get any simpler.
Expenses are the costs to run your business. It includes money you pay to contractors, subscriptions, taxes, etc.
Net Income is how much money you made after you subtract all your expenses.
Your net income might be looking pretty, but don't forget you'll pay roughly 30% in taxes of the net income. Please consult a tax accountant to discuss your personal situation.
Below is a cash basis income statement. It shows all the revenue and expenses for the year to date (at the date of the statement).
The income statement is an amazing tool to visit throughout the month to see if you are on track to make your income goals and how your spending is doing compared to your budget.
The third financial statement you should know about, although it doesn't get much love, is the cash flow statement.
The cash flow statement is made up of information from the balance sheet and the income statement. It is the flow of cash through business over a period of time. Think of it as a check register.
The cash flow statement formula is:
Cash on hand at the start of the period + revenue received - money spent = cash at the end of the period
Let's break it down:
Operating Activities is the breakdown of where your cash came from and how much and where your cash went and how much.
Financing Activities are other expenses such as an owner's draw.
Net Cash Flows is the operating activity less the financing activities.
Cash and Cash Equivalents show the cash you had at the beginning of the period (the start of the statement date) and how much you had at the end of the period (the end of the statement date). It should always equal the net cash flows.
Below is an example of a Statement of Cash Flows showing the cash activity for the year to date.
If you don't know your numbers you don't know your business - Marcus Lemonis
So the Sales account bucket would look like this on the income statement:
Product A $
Product B $
Product C $
Total Sales $
While you are on the road trip of your business, reviewing your financial statements every month can keep you from feeling like you are driving off a cliff on a winding road. Road trips are supposed to be fun, make sure your business's journey is fun too!
Don't be unprepared for rough weather. Update your bookkeeping monthly (at a minimum) and after you reconcile all your accounts, review these financial statements. Doing so will keep your business road trip moving a lot smoother, and keep more money in your pocket!
If you'd like additional accounting definitions and helpful bookkeeping info, check out my free Entrepreneur's Guide to Bookkeeping.
*Note: most entrepreneurs are on cash accounting, not accrual accounting. This post is for the cash accounting business. Cash Basis accounting means you record cash when you receive it and when it is paid out, it operates like your checkbook.