Essentials to Know about Your Small Business Financial Statements
Reading and understanding your small business financial statements is right up there with root canals for many business owners. If you don’t regularly review your financial statements, though, disaster can be right around the corner and you may not even know it.
I’ve wanted to provide a Small Business Financial Statement 101 review for quite a while now, but how do I do it without you nodding off? And besides, the SBA has explained the elements quite well already (see http://www.sba.gov/ombudsman/7046 for detailed descriptions of balance sheet and income statement elements). So instead, let me give you a broad view with quick tips on what you need to be paying attention to.
Income Statement, or Profit and Loss Statement
If you review any of your financials, chances are this is the one you look at. Basically, this is it:
Revenue – expenses = net income.
So, where is the starting point for reviewing this statement? Give every line item a critical review, understanding that if you want to increase net income, one of the other two items – revenue or expenses – must change. You should be looking at it
monthly, compared to the same month last year and to your budget; also review it on a year-to-date basis (and compared to YTD last year and your YTD budget).
That’s a start, but this limited view has its downfalls. Your income statement is historical and has little to do with a critical small business need: cash.
Your balance sheet is a snapshot in time, and shows what you own, what you owe, and what’s left over AT A GIVEN POINT IN TIME. Key items to pay attention to:
- Current Assets compared to Current Liabilities. If necessary, could you cover all of your short term liabilities (what you are required to pay within one year) with your short term assets (what you can turn into cash relatively quickly)? Watching this ratio (called your Current Ratio) will prevent excessive debt, which can quickly turn a business into a mess and even non-existence.
- Accounts Receivable. Consider accounts that owe you money as your customer loan department. If you have provided a service and have not yet been paid for it, you are basically loaning your cash to others. Make sure the business transactions warrant that “loan”.
- Inventory. It’s easy to fall into the trap your distributor reps often set: buying more of an item, giving you a better unit price, is not always a good thing. Inventory is equivalent to dollar bills sitting on your shelf. Make sure inventory will turn quickly enough to provide the income needed to pay bills, provide for you and your staff, and invest further in your business’s long term health.
- Accounts Payable/Loans Payable. This represents what is due to vendors and lenders in the short term, keep this balanced between maximizing the “loan” you take from your vendors with too much debt and keeping your vendor relationships strong. Avoid letting this number creep up without increased sales and cash flow.
Tags: Business Finances