Whether your passion is jewelry making, cake baking or anything else, there's nothing more empowering than following your dream and becoming your own boss. Unfortunately, though, many aspects of being a small-business owner have little to do with your actual trade or craft — and a lot more to do with things like bookkeeping, bill payments and financial statements.
There are a number of business financial statements that each and every small-business owner should be generating and analyzing at least every fiscal quarter, if not once per month. It's not the most fun part of an entrepreneur's job, but they're necessary to be successful with your small business. It's important that you understand what these statements are and how to read them with a critical eye in order to get a comprehensive picture of how you're doing, where you can improve your business's financial health and when you're best positioned to make a move towards growth and expansion.
In the simplest terms, your balance sheet adheres to this basic formula:
ASSETS = LIABILITIES + NET WORTH
This equation always has to balance out, meaning that your company must pay for the things it has (its assets) by either borrowing money (taking on liabilities) or paying for them out of pocket (detracting from your net worth).
When you look at your business's balance sheet, the format will typically follow this equation. On the left side of the document will be listed all of your business's assets, while liabilities are listed on the right. At the bottom of the document, the total of both sides should show that they are equal or "balanced."
Keep in mind that a balance sheet is only a momentary snapshot of your business's financial picture at any given time, so it's most useful when compared to your business's past balance sheets or to the balance sheets of other similar companies.
Sometimes called a profit and loss statement or statement of revenue, your income statement provides a view of your company's financial performance over a particular accounting period — usually a month, quarter or fiscal year.
Income statements are divided into two sections: operating (expenses or revenue directly tied to regular business operations) and nonoperating (expenses or revenue outside of regular operations). Because the income statement tracks your business's performance over time, this financial statement can give you a greater sense of your company's overall fiscal health.
When reviewing your income statement, look for particular highs and lows in sales revenue over time or for major expenses that you can plan for in the future. Also take particular note of your business's percentage of operating vs. nonoperating expenses, as this will help you to seek out and eliminate superfluous expenses that aren't tied to how your business makes money.
Cash Flow Statement
Did you know that poor cash flow management has been identified as the leading reason for business failure? No matter how in-demand your product is or how much money you're making, if you can't manage your cash, your business can't survive. That's why, although it's not the most common, your cash flow statement may be the financial document that deserves your greatest attention.
Unlike the balance sheet and income statement, which focus on accrued (or earned) earnings and expenses, the cash flow statement shows exactly what money is flowing in and out of your business right now. For the purposes of this statement, it doesn't matter if the work was done last week or if the supplies were purchased last year — it only matters when the money is flowing in and out of your bank account(s).
Your cash flow statement should be broken down into cash flows from operations (including accounts payable, amortization and depreciation), investing (cash spent on property and equipment) and financing (cash spent on loans). Positive cash flow means that your company's liquidity (or cash on hand) is growing, meaning in turn that you're able to pay down debts and reinvest in your business. Negative cash flow, on the other hand, could mean that your business is close to not being able to make required payments on debts or other expenses. If you see negative cash flow on your statement and you aren't sure why, it's time to pay attention and take steps to correct the issue before you have a bigger problem.
Accounts Receivable Statement
Accounts receivable (AR) covers all money that your company is owed for goods or services that you've already provided but that your client has not yet paid for. Since you've already done the work or provided the goods, you're essentially guaranteed this money and can tally AR as assets. This AR statement is rolled up into the more comprehensive cash flow statement and contributes to positive cash flow.
Business Debt Schedule
While it's nice to focus on the money you're making, it's important to be aware of money your business owes as well. Sometimes called an accounts payable statement, a business debt schedule is a list of all debts your business owes, including loans, contracts, leases and notes payable. It typically only includes longer-term debts, not costs incurred as part of day-to-day business operations. This type of financial statement is particularly important for businesses that owe money to a number of sources.
If you're just starting your business, you won't have a strong revenue history to point to, which is where a revenue forecast comes in. Forecasting models give you a sense of the expenses you can afford at the outset and act as a guidepost as you continue to grow. However, because a forecast is a best guess rather than hard-and-fast numbers, it will carry less weight with lenders when applying for a loan.
Generating detailed business financial statements will require more than your standard spreadsheet. Investing in accounting software and working with a certified public accountant are two important moves for any small-business owner who wants to get an accurate, reliable picture of their financial health. This will allow you to fully understand what's happening with your company monetarily and will provide lenders with the information they need to finance your business as you continue to expand.