An Entrepreneur’s Guide to Financial Statements
Your financial statements are telling you the story of your business, you just need to learn how to read them. The good news? You don’t need to be an accountant to understand what’s on those statements every month.
Whether you’re running a creative business, a professional practice, a solo e-commerce digital storefront, or a growing company with employees, your financial statements can help you understand some of the most important questions you’ll face as an entrepreneur:
Are we making money?
Where is the money going?
Can we afford to grow?
You don’t need to pore over stacks of accounting textbooks. Start with the two statements that likely matter most to you.
Profit & Loss
The profit and loss report, or income statement, shows you how your business performed over a period of time.
It can be simplified down to a single equation: Revenue - Expenses = Net Income
The revenue shows what your business earned, for many small businesses this is the cash you received for doing what you do best.
The expenses show what it cost to operate the business, this would be what you paid to keep delivering for your customers.
Net income shows what was left of the revenue you brought in once you spent what you needed to on those expenses.
On its face, you might focus on revenue, if you’re earning more money things should be great, right? What happens if revenue is growing but your expenses are growing faster? Are you getting busier without actually seeing more profits at the end of the month?
In general, the special piece that turns an income statement from a collection of numbers into a gameplan for understanding your business? Context.
It’s easy to panic in those months you see a loss on your report, but there could be many reasons driving a loss. Did you make a major investment in the period? Did an annual renewal for a software you rely on come around? Did you hire someone new?
If you’re tracking depreciation, that expense would hit your P&L, but you didn’t pay any cash for it out of your bank. It’s entirely possible your loss is just a ‘paper loss’.
The benefit of the P&L is that you now have all those details organized - when you combine that data with your context for what’s happening in your day-to-day, you create an understanding of your business that will allow you to make informed decisions about where you’re going.
Balance Sheet
The balance sheet shows you two things at a specific moment in time - what your business owes and what your business owns.
It can also be simplified down to a single equation: Assets = Liabilities + Equity
Assets are what your business owns, the things it controls. The cash, equipment, and other resources your business has access to and can leverage to continue operations are valuable assets within your business. These are the pieces that give your business value independent of the work you put into it.
Liabilities are what your business owes. Do you have a business loan? Do you leverage credit cards or lines of credit to fund your day-to-day expenses? Do you have suppliers that have provided you materials that you haven’t been invoiced for yet? Those obligations all make up liabilities to your business, and represent amounts that it needs to pay towards to stay financially healthy and continue operating.
Equity, at its simplest, is what is left over for the owner - at any given moment your equity is what remains if you satisfy all the obligations of your existing liabilities with the assets you own.
The balance sheet is answering a different question from the P&L.
The P&L shows you how your business is performing, what’s flowing in and what it’s flowing out over a particular period. The Balance Sheet shows you what the financial position of your business is when the report is run. A business that’s profitable in a given period can still carry a significant amount of debt, a business that’s unprofitable in that same period may have a strong reserve of cash to withstand a temporary downturn in business.
The Numbers Don’t Disappear
Your financial statements aren’t useful if they’re simply accurate. They need to support your decision-making process as a business owner. The quickest way to get there is by keeping track of that information for longer than just the period when it occurred.
Start looking for trends and information within the statements. Is revenue growing? Are any of your offerings more expensive to deliver to customers than you’re bringing in?
Compare this month’s results to last month’s results, compare your results to what you were budgeting for, watch out for expenses that grow faster than revenue and how much of your business is owned by the business against how much is owed to outside parties.
The tax connection - you can use your statements to help estimate how much you’re projected to owe when the tax bill is due, and how much you should pay in estimates throughout the year to avoid penalties.
Your financial statements are telling you the story of your business all year long.
Are you listening?
Need help making sense of your numbers? Midas Tax & Advisory helps entrepreneurs and business owners turn their financial information into actionable insights.
