The three key financial statements in your business are your Income statement, your balance sheet and your statement of cash flows. Your accounting software can produce all three but it has to be set up properly in advance, beginning with your chart of accounts. Many businesses never set this up properly, or allow their bookkeepers to add to it at random – resulting in “account creep” making their income statement way too long and complicated. If this describes you – take a look at the year-end statement your accountant gives you and how they have simplified it. Your income statement is record of what you sold or spent on direct expenses and overheads in a given period. If you really want to keep it simple – I like to extract some totals from the income statement and look at what I call the profit model:
Less: Direct Costs
= Gross Margin
= Net Margin
It doesn’t have to get any more complicated than that – and if you need more detail – you can get it.
Pay close attention to your margins and learn to control them. In a service based business, because the direct costs are often negligible, I recommend to simplify the equation further by eliminating the second two lines completely.
The balance sheet is a snapshot of who owns what in a moment of time. Providing your entries are up to date – your balance sheet will show you things like – How much cash you have in the bank, how much people owe you (receivables) , how much you owe others (payables), and how much profit you have built up in your business (retained earnings). It also keeps a record of the stuff you have that you own (assets), and the stuff you have that others still own (liabilities). When you make a “capital expenditure”, like investing in new computers – it goes on your balance sheet. Your goal with the balance sheet is to build the equity. A healthy balance sheet means your business is increasing in value. Next time you talk to your accountant, ask he or she to explain it to you (like you are a four year old), and set some goals around it for the coming year.
Finally, we have the statement of cash flows – which is critically important because running out of cash is the number one reason a business will fail. Monitoring your cash flow is akin to monitoring your blood flow, if it stops flowing you are dead! Keep in mind that your income statement or balance sheet does not monitor when money comes in or goes out, so we need a tool to help us balance the flow – ensuring that we always have more money flowing in than we have flowing out. That seems simple right? And it is – but it’s easy to get into denial thinking things are better than they are – like when you are trying to lose weight and don’t count that beer you just had. Take my advice – when it comes to the numbers in your business you want the cold hard truth – good or bad is the best medicine for a healthy business.
Clint Best is a business coach and the founder of Kaizen Business Development in Kelowna, BC. Clint has been guiding forward thinking business owners through change and growth since 2002.