Most Important Financial Reports for Entrepreneurs
For most business owners, understanding cash positions and profitability are two of the most important financial metrics to analyze on a regular basis.
In the post, “Top 3 Bookkeeping Mistakes of Entrepreneurs”, we discuss the importance of maintaining timely and accurate bookkeeping practices - now we’ll discuss the most important reports, or financial statements, to be reviewing on a regular basis in order to have good visibility into the above mentioned metrics - plus a whole lot more..
So what are financial statements?
High level, they are reports that summarize all of the inputs entered into your accounting software (such as QuickBooks Online). The more accurate the inputs, the more reliable the output. Or on the other hand, poor record keeping will result in inaccurate financial statements.
One of the best ways to ensure your financial statements are accurate is by accurately recording and reconciling your cash activity on a timely basis.
So let’s get into it: below, we will discuss two of the most important reports/financial statements that all entrepreneurs should have an understanding of - the P&L and the Balance Sheet.
First, the income statement: this is also referred to as the P&L (Profit and Loss). This report calculates net income over a period of time by deducting expenses from revenue.
The basic format for a small business P&L is the following:
- Revenue: income earned from ordinary operations
- Cost of Goods Sold (COGS): expenses directly correlated with revenue generation. For example, the food costs at a restaurant would be considered COGS.
- Gross profit: this is simply revenue less cogs. It represents the profit you earn on your sales, outside of expenses incurred to run your business.
- General and Administrative expenses (G&A): this represents all other expenses that the business incurs in ordinary operations. Typically a significant component of this is salaries/wages and rent. G&A also includes things like marketing, consulting, occupancy, and various other business expenses.
- Net income: this is essentially all revenues, less all expenses (COGS + G&A).
Why is the P&L important?
In short, it tells you the “bottom line” (I.e net income) for a specific period of time - how much money the business earned in a month, quarter or year. Viewing this in comparison with a prior period (such as this moth compared to last month) can also highlight important trends in your business.
While the P&L shows you the bottom line, it also shows you all of the components to arrive at that number (discussed above), all individually important to understand.
While most people put more focus on the P&L, the balance sheet is equally important. The balance sheet shows the balances of all your assets, liabilities at any given point in time. It essentially shows the financial health of your company at any given point in time (different from the P&L in that the P&L analyzes a period of time, such as a month or year).
As mentioned above, there are three sections of the balance sheet - assets, liabilities and equity. Assets and liabilities are further broken down on the balance sheet between current (short-term) and non-current (long-term).
A good rule of thumb is that if an asset or liability will be settled in less than a year, it is short-term. So cash, credit cards, accounts payable and receivable are all current. Things like loans and fixed assets (buildings, machinery) are non current.
The reason that the balance sheet is so important is because as mentioned above, it shows the financial health of a company as of a point in time, which is not only important to you as a business owner, but also to external stakeholders such as lenders and future equity holders.
To summarize, make sure you are familiar with your P&L and Balance Sheet as an entrepreneur. These can be easily pulled right from your accounting software. Simply locate the Reporting section of your software, identify these reports, and change the parameters in the report for the period being analyzed.
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