We have taken some time in the first few posts to discuss why financial information is important, some of the attributes you want your financial information to have, and how to assess/improve the process of collecting financial information. Now let’s dive into some types of financial information.
The first and best source of financial information are your financial statements. Even the most simple (a statement containing very few accounts) can provide you with valuable information about your company’s performance. Regular review of the financial statements is the first step to accuracy in your financial information. You need to understand and get used to the flow of financial data through your financial statements in order to identify incorrect information. An understanding of the financial statements also is the first step to changing how you quantify the data in them (adding detail through more accounts or a system of classes) to give yourself more information to make better decisions.
Types of financial statements – There are three basic financial statements
- The Balance sheet – Think of this statement as a “snapshot” of your business on a particular day. It quantifies the “net worth” of your business on that particular day. It shows everything you own (assets), everything you owe (liabilities), and the difference between the two (equity). The balance sheet accounts are called permanent accounts because they are the summation of all the activity in the company since its inception.
- The Profit and Loss Statement (P&L) – This statement is not a snapshot in time but rather a report of operations over a given period of time. The P&L shows the revenue (can be called sales) during that period as well as the expenses for the period. The difference between the two is Net Income (revenue higher than expenses) or Net loss (opposite). There are different formats for the P&L. We will discuss more about them later. The different formats are aimed at presenting the information in a way that gives P&L readers the most useful information for their type of business (a service business would have a different P&L format from a manufacturing business). The profit and loss accounts are called temporary accounts. They are used to accumulate activity for a period of a year and then they are closed out (reset to zero) into the balance sheet (permanent) accounts.
- The Cash Flow Statement – The cash flow statement is the most misunderstood and underused statement of the three. It is also the statement that answers the question I get asked most by small business owners. “If I make $xxxx.xx of profit, how come I don’t have $xxxx.xx in my checking account?” The cash flow statement will tell you why you have less or more cash than you have profit or loss. The cash flow statement is also not a snapshot; it’s for a period of time. It starts with your profit or loss for the period of time and then shows the creation (inflows) or uses (outflows) of cash. It segregates the creation and uses of cash by three different types of activities (this segregation is useful for information purposes). The three categories are Operating Activities (regular business activities), Financing Activities (purchase or sale of assets), and Investing Activities (debt or equity financing or the repayment of debt). There will be more posts dedicated to the cash flow statement in the near future. What you should remember now is the cash flow statement is a very important source of information and for a given time period shows you why your cash (checking account) balance changed.
