How to make Better Decisions by Understanding Your Financial Statements￼
We want to share some insights for understanding your financials. We’ll specifically talk about the balance sheet and profit and loss statement. Too many business owners have the mindset that they’ll never understand them. I’m not expecting financial statement expertise, just an understanding to better understand your business. Which will lead to good business decisions or better decisions if you’re already making good ones.
The balance sheet is the last financial to be considered because it seems like the most complicated and often gets completely overlooked. Here’s a breakdown of how this financial is organized. It’s based on a mathematical formula.
Assets = Liabilities + Equity
The point of the balance sheet is to balance assets with liabilities and equity. When you’re looking at it, it flows in that order from top to bottom. The asset section is the uses of your funds. Think to yourself what assets did you use your money on. Like you used some funds to buy equipment, so that amount will be noted in the fixed asset area. If you happen to have extra money in the bank account that you haven’t used yet, that account balance is noted as an asset.
Liabilities and equity are the sources of your funds. Think to yourself where did the money come from to use to purchase an asset. Liabilities are basically debt. Those are funds you received that will need to be paid back. Equity is what the owners put into the business themselves. Those funds you don’t have to pay back.
So, you are comparing the funds you have received to the funds used and waiting to be used to make sure they match. If they don’t, that’s a problem that needs to be solved immediately.
Profit and Loss Statement
The profit and loss statement or income statement tracks basically the value generating activities and the value taking activities. Here’s the formula.
Sales – Expenses = Income
Just like the balance sheet, the profit and loss statement is organized just like its formula. Sales or revenue on top, then expenses, then net income or profit. The very first thing under total revenue is to subtract the cost of goods sold (COGS) as the first expense. That gives us the gross profit, or we like to call it real revenue. Because the COGS were essential to generating that income. The other expenses were only indirectly involved.
Then we list our all expenses, which are your value taking activities. A better way to think about value taking activities is they are your attempt at investing in expenses that you hope will give a return of some kind. For example, paying for a cleaner for your gym doesn’t seem like an investment, but it does allow you as the owner to spend more time on value creating activities instead. The return is time, which will hopefully turn to more money in the future. Now the hope is you should have confidence that your expenses are going to provide a return of some kind.
So, you take all those expenses and subtract them from your real revenue to get your net income. The goal is obviously for that number to be positive and really as high as possible.
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The point of the financial statements is to show you the health of your business. In order for that data to be effective in helping you make better decisions, it has to be compared to something else. Like to people in your industry that do what you do, but at a higher level. That will give you something to work toward. A more important benchmark to compare with is yourself. Compare to previous years or compare from previous months. What this should do is lead to questions. Why is this different? Or what lead to those numbers?
The point is to ask questions, which will then lead to insights that let you as the owner make better decisions for the health of your business. Those insights come from comparisons.
Every business owner is capable of understanding their financials enough to put themselves in a position to use those facts to make better decisions. This knowledge will help you stay in business as long as you choose, instead of being forced out of business for poor decisions.
Whether you’re just starting out or you have a successful business, lets improve our financial understanding so we can continually improve our decision-making capability.
Use this to empower yourself and keep improving the health of your community.
If you want to learn more you can Schedule with one of Incite’s professionals.