It is scary to me how many business owners cannot read their own company financial statements let alone understand them. Any business owner who wants to grow their business should have at least a basic understanding.
So here we go:
The two basic Financial Statements are the Balance Sheet and the Profit & Loss Statement or P & L.
The Balance Sheet is a reflection of the financial makeup and standing of the company at any point in time – usually month-end. It is a roll-up of every transaction that company has done from day-one to present. The Balance Sheet reflects EVERYTHING that has happened in the including Profit or Loss (more on that Later).
The Balance Sheet is made up of three broad categories:
• Assets – The things the company owns: Cash, Accounts Receivable, Inventory, Land, Equipment, etc. If you prepay insurance or some other purchase, you would also post an asset entry here.
• Liabilities – The debts of the company: Accounts Payable, Bank Debt, Car Loans, etc. They are split up between Current Liabilities (the money due within the current fiscal year) and Long-Term Debt (Amounts due beyond the current fiscal year).
• Net Worth (or Owners Equity) – Any money invested in the company minus any payout to the owners plus the net total of all annual profits (negative for losses) since day one (called Retained Earnings) plus the total of profits (negative for losses) in the current year.
The total Assets always equals the total of liabilities plus net worth. Simply put
Assets= Liabilities + Net Worth.
Not too difficult, huh?
Now let’s talk about the Profit & Loss Statement or P & L:
The P & L is a reflection of all Revenues and Expenses for the current year: in other words, the company’s profitability.
• Revenue – Is the money generated from the activities of the business.
• Expense – Is the money spent in the pursuit of revenue for the business
• The bottom-line number is Net Profit, which = all Revenues less all Expenses.
Remember I said earlier that the Balance Sheet reflects ALL transactions of the company?
• The Net Profit total of the P & L flows to the Balance Sheet as the total Current Year Profits in the Net Worth section. At each year-end, the P & L zeros out to begin a new year.
• On the Balance Sheet, the current year profit in the Net Worth section transfers to the Retained Earnings total and the current year profit value goes back to zero for the start of a new year.
If you are confused, read this a couple of time and you will get the hang of it. This is where beginning accounting students start getting glaze-eyed, but it is not that tough. Just sleep on it.
Finally and the most important part of the Balance Sheet and the Profit and Loss Statement is making sure you are capturing all the transactions of your business in a timely manner. Having a good bookkeeping system in place will:
• Give you an accurate picture of what your company is doing.
• Guide you in making strategic business decisions.
• Save you money in CPA fees.
• Find out where money is being wasted.
• And so much more.