For some entrepreneurs, putting together your financial statements can seem like busywork. You have a business to run, so can’t your accountant just whip up what you need and send it off wherever it needs to go? Theoretically, sure. But the most forward-looking business owners understand that doing the numbers isn’t just perfunctory.
That’s because your financial statements tell very specific stories about your business. What they say could have a big impact have on your company’s cash flow and future. But, it all depends on who’s looking, and, of course, the numbers themselves. (See what kind of stories unfold with Smansha’s cash flow forecasting.)
The first 3 chapters in your financial story
We’re not talking about just any financial information. We’re talking about three business financial statements very specifically — what we at Smansha (and most everyone else) look at as the accounting trifecta. Together, the income statement, balance sheet, and cash flow statement give the full picture of how your company is performing financially.
If you’ve never heard the term “income statement” or “statement of income,” then you’ve probably heard “Profit & Loss” (or just “P&L”). Whichever term you know, they all mean the same thing.
Your income statement is the first massively important document in the trifecta. Briefly, it shows you whether or not your business is making a profit. It also reveals where you’re earning and where you’re spending — and, naturally, whether you’re spending more than you’re earning.
That alone can tell a story, but what’s especially notable about your P&L is that it tracks data over a specific period of time. Many business owners do them quarterly, and, at a minimum, yearly. Some even choose to draw up an income statement every month to be able to get a more consistent pulse on trends.
Next up is your balance sheet. Like your income statement, this also has another name — the “statement of financial positioning.” It centers on a simple but telling equation to allow you to see your business’s net worth:
Assets = Liabilities + Equity.
In contrast to the P&L, your balance sheet looks at a specific moment in time. This is an important difference when you’re thinking about the stories that your accounting documentation tells, especially because circumstances change so rapidly in business. Due to accounts receivable and payable, among other factors, how your finances look on one given day can — and likely will — be very different compared to another. Even if it’s just a week later.
Cash flow statement
Rounding out the three, your cash flow statement. (And, our personal favorite at Smansha. Because, absolutely, we have a favorite financial statement.) Your cash flow statement — or “statement of cash flows” — shows the movement of cash into and out of your business. That includes your investments, operations, and any financing you have, too.
We mention cash flow last certainly not because it’s least. Far from it — in fact, most small businesses fizzle due to poor cash flow management and the subsequent lack of capital. Rather, it’s important to understand your P&L and balance sheet first because your cash flow statement ties directly into numbers that appear on both. It pulls from amounts on each. It also supplements them with additional insights.
What your financial statements reveal
Alone, your three financial statements certainly help you get a picture of how your business is doing. But it’s sort of like reading through a book without vowels. You can get through the story, but the words are incomplete. Plus, you won’t understand how the writer intended you to get through the book. You miss the insight into the language that having every last letter provides.
And there are a lot of stories hidden in your accounting documentation! You’ll want to make sure you understand what some of the most important big ones are saying about your company.
1. How well you budget your cash flow
Since cash flow is a big component of all three of your statements, you’d likely expect that you can gather a lot about your business’s cash flow when you look at all of them. What you can especially see? If you’re good with that cash. Which, as we mentioned before, is a major part of your company’s likelihood of survival.
Among the things those evaluating your cash position will be able to see are:
- If you keep consistent — and right-sized — reserves.
- If you have a tendency to hedge for emergencies or if you lean on financing often.
- If you experience — and anticipate seasonal — fluctuation in revenues.
- If and when you invest your cash, and how it affects your ability to pay your outstanding bills.
- If you correctly manage your trade credit relationships.
2. How you manage your working capital
You have money to put into your business? That’s great news. Working capital is a huge sticking point for lots of small-to-medium enterprises (SMEs) who need access to more funds to initiate growth phases. Many businesses seek financing specifically for working capital, so it’s important to know if you’re using your own productively.
Your financial statements will reveal a lot, including:
- If you’re keeping too much working capital on hand instead of investing it.
- If, on the other hand, you’re investing too much and not keeping enough in reserves.
- If your investments are incorrectly distributed to accelerate growth.
- If you’ve put too many resources into one asset class versus another preventing maximum return on investment (ROI).
3. If you’re making the money you could — or should — be
Whether or not your business is maximizing its revenues can end up being a subjective conversation. There are a few things about the conversation, though, that aren’t a matter of opinion. Or, at a minimum, are less debatable than others.
Your statements will shed light on:
- If your profit margins are too slim, and, relatedly if your cost of goods (COGS) is too high.
- If your raw materials are increasing faster than you’re raising your prices or getting better terms with suppliers to sustain your margins.
- If you’ve created a sustainable monthly recurring revenue (MRR) model.
- If you’re pricing similarly to others in your sector — and making the same margins.
- If your fixed and variable costs are on target or should be adjusted so you can net more profit.
4. Where you fall relative to industry peers
Benchmarking is an important concept in business. It’s helpful for you to know where you stand relative to others in your sector, and for outsiders evaluating your company to get an objective sense on how you’re doing. It also allows industry experts to be able to map you in your competitive landscape.
Your financial statements will help with benchmarking by:
- If you’re growing are the same rate as comparable companies.
- If current economic conditions are impacting you differently than peers.
- If you’re allocating your capital in substantially different ways, or your operating costs are relatively significantly higher or lower.
- If you’ll hit profitability before other major competitors.
5. If your capital asks are realistic
There comes a point in the life cycle of many SMEs when you’ll want to borrow money. It’s not a badge of shame — far from it, actually. Many entrepreneurs look for business financing when they want to accelerate their growth or seize an opportunity. And no amount of savvy cash flow management or diligent recordkeeping can see the future.
If you’re asking for a loan or an investment, your statements will be able to expand on:
- If you have the cash flow to be able to pay back a lender in the case of a loan.
- If you have consistent revenue history that makes you a good candidate for a term loan.
- If you’re in a hyper-growth stage, or your business is on the decline.
- If you already have a lot of outstanding debt.
- If you don’t have enough equity left to offer.
Who interprets these stories (and why it matters)
You can learn a lot about your business from gigantic stacks of paperwork — but, other than the taxman, who cares? Many people, actually. (FYI, your income statement is of primary concern to the tax folks.)
When the time comes that you do want to borrow money, your financial statements matter. A lot. They’re the bulk of your loan application, and your underwriter will scrutinize them with a fine-toothed comb. (Don’t worry. They’re just doing their very reasonable but equally thorough jobs.)
That’s all to say that if your financial statements give off the wrong impression to a small business lender, you won’t get the money you might very much need. Or, with the terms you desire.
With business lending, your approval and subsequent terms are all about mitigating risk. A lender won’t allow you to borrow money if they don’t think you’ll pay it back. And, if you do get the green light, they still won’t give you favorable terms if your financials tell the story that you’re a high-risk borrower.
As they examine your accounting documents, especially your balance sheet and cash flow documentation, you want to make sure you present a super-responsible business owner. Liquidity is important here: Above all, they want to see they the story that you’re a safe bet to be able to pay back their money on time and in full.
The process of due diligence with an investor interested in your company is a short way to say “a deep dive into every financial document you’ve ever touched.” (They’ll talk to your friends and enemies, too.) As well they should! If someone is going to put their own cash into your business without any guaranteed return, you better have something better than solvent.
Of course, the quickest way for them to be able to tell if that’s the case is looking at your accounting trifecta. Investors are going to care quite a bit how you’re spending money, why you’re spending it, and your performance relative to your major competitors. If you have a good history with how your financial management, when you hire, etc, it’s a good chance that you’ll make their money work hard, too.
Investors want to see the story of your growth and your path to profitability. There are a lot of ways to illustrate that with meetings and pitch decks. You’ll have the chance to do that, but make sure you seize the opportunity to do so with your finances, too.
Potential business partners
There are lots of different types of business relationships: You could bring on a partner, acquire another company or sell your own, or simply establish a trade credit agreement with a major new supplier. Whatever you’re pursuing, all of these different arrangements are big deals. Don’t be surprised if the party you’re transacting with asks to open your books.
As good as your word is, it’s only as good as your last paid invoice or your last sale. And as much as you can find out from a business’s credit score — which is public information, by the way! Potential partners can only feel great about a major transaction, or even offering net terms when they feel satisfied that they know the story of your business.
Remember that the decisions you make with your company have implications for your partners. Poor cash flow management leads to a delinquent payment leads to turtles all the way down.
How to understand exactly what your financials say
You never want to be in a position where someone understands something about your business that you don’t. Especially anyone who’s in a position to change the trajectory of your future. So, you have to know all of the storylines that your financials contain — and know them first, and better, than anyone else.
The only way to see the whole picture is to collect all of the puzzle pieces. So, yes, that means all three statements. But it’s even more granular than that — you need all of the data and insights that power the numbers on each of those documents. Like we said before, more information empowers you, not less.
A cash flow forecast from Smansha adds a ton of depth into knowing how your business is doing. You’ll be able to understand the financial statement trifecta and make adjustments to get your company on the path it should be. Signing up is easy — just connect your free Smansha account to your QuickBooks Online account. Your forecast is also free. Get started today! (If you don’t have QBO, hang tight. We’re working on other integrations as we speak).
The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.
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