In today’s uncertain economy, many business owners are having to take a serious look at their business, how it operates, where the money comes from, where it goes and most importantly…how to hang onto it. In the last decade that I have coached plumbers, well-drillers and independent water dealers, I’ve noticed a common thread.
Most small business owners are entrepreneurs; Webster’s defines an entrepreneur as someone who “organizes, manages and assumes the risks of a business or enterprise.” Entrepreneurs have great ideas and the courage to turn those ideas into reality. Most entrepreneurs I meet are happy slaving away working for their business to produce ‘results,’ but those ‘results’ are difficult to quantify because they don’t truly understand their business.
Learning how to read a financial statement is one of the most important aspects of running your business. Imagine playing a football game without watching the scoreboard; if you don’t know you’re trailing, failing to adapt and modify your techniques will cause your team to lose.
It’s important that you understand small business accounting so you’ll know your company scoreboard. Learning how to read a financial statement will help you survive today’s challenging business environment and possibly even make your business work hard for you !
Keep good records
I know, you’re busy; you’re answering the phone, dealing with complaint customers, handling difficult employees, making sales calls, installing equipment and performing the myriad responsibilities that make you the boss. STOP ! Take the time to keep good records.
Without a record of business activity, you don’t even have a business, just an expensive hobby. You need to keep track of inventory, customers, transactions and general financial activity in your business before you can even realistically attempt to be successful.
Accounting basics
‘Accounting ‘ is a scary term to many business owners. There are three accounting documents that are easy to understand:
Balance Sheet – A snapshot of your company right now—Your company’s financial scorecard
Income Statement – A record of activity over a period of time. – The details of where money came into your business during the time between balance sheets. This is the ‘P&L’ (Profit & Loss) Statement that you hear people trying to sound smart about.
Cashflow Statement – Simply a record of the company’s cash flow over a particular period of time.
The Balance Sheet is divided into two financially equal sides, hence the name. Assets live in the left column and Liabilities + Owner’s equity are on the right (i.e. Assets = Liabilities + Owner’s Equity).
The key to a balance sheet is connecting the things (left side) to the people/entities who own them (right side). Assets (what we own) are organized on the balance sheet in descending order of liquidity (i.e. how easy it is to convert the asset into cash).
Balance Sheet
| Assets | Liabilities and Owners’ Equity | |||
| Cash |
$6,600 |
Liabilities | ||
| Accounts Receivable |
$16,200 |
Notes Payable |
$40,000 |
|
| Accounts Payable | ||||
|
Total liabilities |
$40,000 |
|||
| Tools and equipment |
$25,000 |
Owners’ equity | ||
| Capital Stock |
$7,000 |
|||
| Retained Earnings |
$800 |
|||
|
Total owners’ equity |
$7,800 |
|||
| Total |
$47,800 |
Total |
$47,800 |
|
The following represents the order on the Balance Sheet:
Assets
Cash – money that you can use immediately
Accounts Receivable – money owed to you (e.g. for items you sold on store credit but haven’t received money)
Inventory – all available materials that will be sold; includes raw materials (resin, tanks, valves, risers, brine tanks) and finished goods (softeners)
Prepaid Expenses – Money you’ve already spent on things that you haven’t used
Fixed Assets – Items that are in continuous use and you have no intention of selling.
Liabilities + Owner’s Equity are organized into the following:
Accounts Payable (Liability) – the value of the inventory you borrowed and now owe; usually have to be paid back in 30 days
Notes Payable (Liability) – the loan amount in money you borrowed and must owe; payable over long-term
Tax Liability (Liability) – taxes you owe the government and the Original Investment
Owner’s Equity – your personal money invested in your business.
Retained Earnings – earnings from past accounting periods; shows retained ‘net profit’
Retained Earnings [Week, Month, Year] to Date (O) – earnings from present accounting period; shows the period’s ‘net profit’ (the bottom line)
Income Statement (P&L)
| Income Statement for SOFT WATER COMPANY, LLC | |||||||
|
$ |
$ |
||||||
| Revenues | |||||||
| Gross Profit (Including Rental Income) | $ 550,000.00 | ||||||
| Expenses: | |||||||
| Advertising | $ 12,000.00 | ||||||
| Insurance | $ 5,000.00 | ||||||
| Legal & Professional Services | $ 1,000.00 | ||||||
| Rent | $ 500.00 | ||||||
| Utilities | $ 1,000.00 | ||||||
| Printing, Postage & Stationery | $ 545.00 | ||||||
| Entertainment | $ 7,830.00 | ||||||
| Licensing | $ 5,000.00 | ||||||
| Bank & Credit Card Fees | $ 1,045.00 | ||||||
| Bookkeeping | $ 5,930.00 | ||||||
| Employees | $ 80,000.00 | ||||||
| Rent, Mortgage & Fees | $ 100,000.00 | ||||||
| Equipment | $ 200,000.00 | ||||||
| Total Expenses | $ 419,850.00 | ||||||
| Net Income | $ 130,150.00 | ||||||
The Income Statement shows you how the Net Profit was gained between the beginning balance sheet and the ending balance sheet. It shows if your business was profitable in a certain period.
Cash Flow Statement
| Statement of Cash Flow for SOFT WATER COMPANY, LLC | ||||
| for the period 01/01/2008 to 12/31/2008 | ||||
| Cash flow from operations | $ 40,000.00 | |||
| Cash flow from investing | $ (10,000.00) | |||
| Cash flow from financing | $ (2,000.00) | |||
| Net increase/decrease in cash | $ 28,000.00 | |||
The Cash Flow Statement is probably the most important sheet in your small business accounting papers, as it keeps track of your cash. Remember that you might be profitable on paper, but without necessary cash, your business is in serious trouble. You can’t spend your earnings, otherwise known as ‘paper profits’; you can only spend cash to fund your operating capital (e.g. fixed costs).
Good cash flow management means ethically delaying your payables as long as you can, while speeding up your collection of accounts receivable money owed to you. The cash flow statement accounts for collections, inventory paid, fixed asset investment and expenses paid.
Once you understand how to read these three documents, you’re well on your way to running a successful business.