Numbers are intimidating for a lot of business owners. They don’t want to stare at spreadsheets and graphs. They want to create and serve customers, not pore over data.
But even if you use a popular accounting tool or hire someone to manage your books and organize your financial data for you, it’s important to at least understand your numbers. Poor financial data and intelligence has destroyed many businesses.Poor financial data and intelligence has destroyed many businesses. Click To Tweet
Your financial data tells you a story about your business so you can make smart decisions. Can you afford that new employee? Can you expand into a new office? Does that product or service actually make money?
These are questions you have to ask yourself regularly to ensure the health of your company. Without information at your fingertips, you’re apt to miss opportunities or make decisions based on bad information.
Why is it important to have access to good financial data?
- It helps you price your products and services accurately.
- It keeps you honest with your tax agency so you don’t pay penalties and interest.
- It helps you know whether you’re making money (in general and on specific jobs/projects).
- It helps you make good decisions when hiring, borrowing money, and working with investors.
- It tells you where your actual budget varied from your predictions.
- It helps you understand when it’s time to scale your business.
There are many different types of financial reports. As your business grows, your reporting needs will grow too. You might eventually need an obscure report for an unusual need. You may even have to create a report that’s entirely unique to your business.
But here are the three financial reports every business should produce. These will help you take great steps toward understanding and controlling your money.
1. Balance Sheet
A balance sheet is an overall snapshot of the financial position of the business at a point in time, including assets owned, amounts owed to third parties, and equity in the business.
The top section of a balance sheet displays your assets, both current and fixed. Current assets include cash and anything you can convert to cash within a year, such as inventory, prepaid expenses, accounts receivable, etc.
Fixed assets include things such as equipment (furniture, manufacturing tools, vehicles, etc.) and property. Generally, fixed assets are things you don’t intend to sell or couldn’t sell quickly to raise cash.
The bottom section of your balance sheet shows your liabilities (what you owe) and the owner’s equity in the company.
There are two types of liabilities: short-term and long-term. Short-term liabilities include accounts payable and taxes. Long-term liabilities include debt and financing, like bank loans or notes payable to shareholders. Owner’s equity includes any invested capital or retained earnings.
Related Reading: 6 Ways to Access Short Term Financing For Your Startup
The top section should always equal the bottom section. (Hence the term “balance.”) This is the “accounting equation.” Assets = liabilities + owner’s equity. If these two sections don’t equal one another, you’ve made a mistake somewhere.
2. Profit and Loss (P&L)
A profit & loss is the report most businesses are familiar with because it’s the easiest to read and understand.
A P&L is an indication of the business’ financial performance over a particular period of time – usually a few months or a year. It can be used monitor particular KPIs and predict future performance. P&Ls are also called income statements.
The P&L tracks sales and expenses. The difference between these two data points is your net profit. The calculation is fairly straightforward: Income minus the cost of sales equals your gross margin. Your gross margin minus your fixed operating expenses equals your net profit.
If your net earnings are positive, you’re making a profit. If they’re negative, you’re making a loss.
Unlike your balance sheet (which shows your financial position at a point in time), your P&L shows sales and expenses over time. This is why it’s important to consider costs beyond your cost of goods sold (what you need to sell your service/product). You should also account for things like insurance, payroll taxes, equipment repairs, legal fees, utilities, interest, depreciation, etc.
With the information from your P&L, you can calculate profitability ratios. These metrics boil down your dollar amounts to percentages. You can then compare the percentages to your past performance, your competitors, or other similar companies. When you hear in the news something like “Coca Cola grew 2% this quarter,” they’re referring to these ratios.
3. Cash Flow Forecast
The cash flow forecast is one of a business’ most important financial documents.
Unfortunately, it’s also one of the reports business owners tend to ignore.
Imagine two scenarios:
- You pass on an opportunity because you don’t think you can afford it. Later you realize you had plenty of cash all along, but miss out.
- You invest in an opportunity because you think you have plenty of cash. Later you realize you can’t afford it, so you have to pay with credit or forgo something else.
Both scenarios are inefficient and wasteful. If you’d had a better understanding of your cash situation, you could have made a smarter decision. This is why it’s important to create a regular cash flow forecast.
Cash flow forecasts are forward-looking reports. They help you predict cash surpluses and shortages long before they happen so you aren’t surprised.
A cash flow forecast shows your predicted cash inflows and outflows. Cash inflows are cash sales, loans, investments, and accounts receivable collections. Outflows are expenses paid, assets purchased, inventory, draws, distributions, and other payments.
To develop a cash-flow forecast it is useful to look at the past to determine your regular cash inflows and outflows. The Cash Summary report in Xero can help with this.
Understanding your future cash situation is important if you ever need to purchase equipment, buy subscription services, secure loans, or hire new staff. A cash flow forecast would tell if you these expenditures are possible or if you need to grow sales first, or if new expenses would actually put you in a weaker position.
Essentially, a cash flow forecast helps you make better business decisions because it’s a fast and targeted way of identifying the future cash position of your business.
Admittedly, the cash flow forecast can be difficult to produce and understand, which is probably the primary reason so many businesses skip it.
However, your bookkeeper should be able to help you understand this document. At Bean Ninjas, we try to make sure our customers understand the reports we give them so they can make strong, informed business decisions.
Establish a Reporting Schedule
We’ve discussed three financial reports that are critical for every business. However these reports aren’t much use if they are provided months after the end of the reporting period and are out of date by the time you look at them.
It is difficult for a small business to have these reports available on a daily basis (because it takes time to prepare and check the reports), but you should establish a regular reporting schedule (ideally monthly) with due dates. You should also create time on your calendar to review your financial reports. (One way to spend more time reviewing your figures and making decisions would be to outsource your bookkeeping).
For over three years, the team at Bean Ninjas has produced Balance Sheets and Profit and Loss Statements (among other reports) for our clients regularly on their preferred schedules. We also help them understand and leverage their reports to meet their needs. Learn more about what it’s like working with us here.