There are three statements you need to understand to make sense of your business namely: the balance sheet statement, the income statement and the cash flow statement. As a business owner, you need to keep track of cash, assets, liabilities, operating income and expenses, other income and other expenses. Thereby, the need for these three statements.
Sometimes people jump into business without having clear goals or even know why they do what they do. This translates into not understanding the business report cards also known as financial statements. You have to understand you are in business to build assets and you do that by earning income. Understanding financial statements is the first step to positioning for growth.
The Balance sheet
If a business was a student in a classroom, the balance sheet statement will be the grade book. The balance sheet measures how good a job you have done in building the assets of your business. It keeps track of:
- Every cash you spent in your business that still has future benefit (assets like computer)
- Money you received less what you have paid on your debt
- All the money you have made to date less what you have spent (retained earnings)
The balance sheet tells you what your business is worth.
Income Statement
If the balance sheet statement is a score card, the income statement is the lesson plan. It details how you do what you do. The income statement also tells how much you have made versus how much you have spent. At the end of the day, what really matters is how much you get to keep.
The 2 things you need to know about an income statement are:
- How much you make
- How much you spend
How much you make
There are 2 ways you make money in your business. The first way is from operations and the second way is by reinvesting your earnings into other endeavors. For example, you can choose to buy mutual funds with extra cash in your business.
The money from your main operations is called operating income and any other income not from your operations is called other income.
A good income statement is one that shows more revenue/ income than expenses.
How much you spend
The income keeps track of cash you spend in keeping the lights on in your business. It also tracks other expenses that result from investments in your business. These expenses are called other expenses.
Cash flow
The cash flow is the peanut butter of a financial statement. It helps you connect the dots between the 2 slices of bread known as the income statement and balance sheet statement. The cash flow statement tells you how much cash you move in your business and where it comes from. The cash flow statement divides the sources of cash into three main categories:
- Money in and out from operations or running your business
- Money you receive or spend from making investments in your business
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Money you receive or spend in financing your business
These transactions can be further broken down into cash in and cash out transactions. Cash in transactions come from the following sources:
- Money you receive from running your business
- Money you receive from investors
- Money you receive from loans
- Money you receive from investments you make in your business
Money you spend in your business can take the following forms:
- Money you spend on operations
- Money you spend on investments
- Money you spend paying back debt
- Money you pay to investors
Cash is the lifeblood of any business and the cash flow statement does a great job of telling you how much cash you have and where it came from.
In the next post how will talk about the flow of transactions between these statements and delve more into categorizing transactions so it appears on the right financial statement.