Americans filed paperwork to start 4.3 million businesses last year, according to data from the Census Bureau, a 24 percent increase from the year before and by far the most in the decade and a half that the government has kept track. Applications are on a track to be even higher this year. The surge is a very unexpected and startling turnaround after a 40-year decline in U.S. entrepreneurship. In 1980, 12 percent of employers were new businesses; by 2018, the most recent year for which data is available, that share had fallen to 8 percent. With more and more people starting businesses, it is even more imperative to learn the language of business. Most people are not equipped to run a business in all of it’s areas as people start businesses out of a talent or a passion. Without having a strong financial foundation, most businesses fail before they hit the 5 year mark. Running out of cash and not managing cash properly tends to be the biggest failure reasons. According to Entrepreneur magazine, only 20 percent fail within the first year but 50 percent fail within the first five years.
What is the language of business? Most business owners would say that it is not English. And in fairness, unless you took an Accounting class somewhere in your academic life, it is likely that this will be a foreign language. Warren Buffet says that in order for you to understand business, or even how stocks work, you must understand the basics of reading financial statements. Every business will have financial statements, and if they are not in good shape, the business will suffer. This is where many small businesses get it wrong. They wait until they are doing really well and gathering momentum, or they wait until something goes wrong---like the IRS or Department of Revenue sends them a not-so-nice letter. Most businesses also comingle their personal funds with business, not really giving them a clear picture of how the business is really doing. How can you know if you are pricing your product or service correctly if you do not even know your profit margin? There is that foreign language again. It can make any educated human being cringe. My suggestion is that you get ahead of the game, and not only hire help in this area, but also educate yourself a bit on what this language is all about.
So, what are the financial statements? Well, they are comprised of three main documents: The Balance Sheet, Profit & Loss Statement (aka Income Statement), , and the Cash Flows Statement. The third is nice to have but not always necessary as it takes data from the first two to show how cash is flowing in and out of the business. It is important to have a proper Chart of Accounts that are the foundation of financial statements. The Chart of Accounts is the entire category system whereby all of your monetary transactions will be captured. If this is not carefully planned out in the beginning it is like having garbage in and hence, garbage out. A good accountant can help you come up with this listing. There is a certain naming for each category that is accepted in U.S. based financial statements. So what actually is on these statements? Below, is a summary of what each one captures.
BALANCE SHEET
The balance sheet is the only statement which applies to a single point in time of a business' calendar year. A balance sheet has two sides: assets on one side (the top), and financing on the other (the bottom)–which itself has two parts: liabilities and ownership equity. Assets are usually listed first, and in order of liquidity. Liabilities are listed next. The difference between the assets and the liabilities is known as equity, or the net worth of the company. Equity must equal assets minus liabilities. Looking at the equation in this way shows how assets were financed: either by borrowing money (liability) or by using the owner's money (owner's or shareholders' equity). The two sections must balance, hence the name of this financial statement.
PROFIT & LOSS STATEMENT
The P&L statement, often referred to as the income statement, is a financial statement that summarizes the revenues and expenses incurred during a specific period of time, usually a calendar month, year, or quarter. These records provide information about a company's ability (or inability) to generate profit by increasing revenue, reducing costs, or both. This information is key in making business decisions.
CASH FLOWS STATEMENT
The purpose of a cash flow statement is to provide a detailed picture of what happened to a business’s cash during a specified period of time. It demonstrates an organization’s ability to operate in the short and long term, based on how much cash is flowing into and out of the business.The cash flow statement is typically broken into three sections:
Operating activities detail cash flow that’s generated once the company delivers its regular goods or services, and includes both revenue and expenses. Investing activities include cash flow from purchasing or selling assets and Financing activities detail cash flow from both debt and equity financing.
There are several books I recommend on understanding accounting basics that will be worth your time to read so that you can have educated discussions with your investors, bankers and accountant. As well, as just feel empowered even more in running your business.
These are books I recommend and are available on Amazon:
“How Much Does It Cost to Make a Donut?: And Other Questions That Make Us Hate Accounting+ (By Cassmer Ward-a local Charlotte NC resident)
“Managing By The Numbers: A Commonsense Guide To Understanding And Using Your Company's Financials” (By Chuck Kremer and Ron Rizzuto)
“Stark Naked Numbers: Uncover Your Financials, Unlock Your Cash, and Unleash Your Profits” ( By Jason Frederick Andrew)
Get ahead of the game, and arm yourself with knowledge. Knowledge is power!
