To own and operate a business means being involved in every aspect of that business. As the owner you are the COO and the CEO. You must understand how the front office, or operations of the business, run and the back office. You don’t necessarily need to work in the back office but you need to oversee it just as you would the front end.
The most important duty in the back office that you need to understand is the financial workings of your business. You need to know the who, what, when, where, and how of all monies coming and going in your business. And the easiest way to understand these comings and goings is to be able to read a financial statement.
Now most business owners know how to READ a profit and loss but they don’t UNDERSTAND how to read it. I’ll explain that further below.
According to wikipedia, a financial statement is “a formal record of the financial activities of a business, person, or other entity”. They collectively tell you what finances are truely keeping your business a float. However, individually they each provide you with different types of information.
This formal record of financial activities consist of 4 primary or key reports.
Balance Sheet. A balance sheet tells you the financial position of your business at any given point in time. It shows all of the assets you own and all of the debt and liabilities you owe. This statement maintains a continuous balance from inception.
Profit and Loss. A profit and loss tells you all of income and expenses incurred during a specified period of time, and whether your business net a profit or loss. This statement is not continuous. The balances reset every twelve month period.
Statement of Cash Flow. A statement of cash flow explains the flow of your cash activities using three “buckets”. These buckets tell the truth about how your business is running from day to day.
Operating activities are the cash received or expenses from the operations of the business. The monies received and paid are based on what you do.
Investing activities are the cash received or paid out for assets needed to keep your business going. Examples are machinery and equipment used in the business.
Financing activities are the cash loaned out or borrowed to/from people or entities that are used for working capital. These funds could be used for the above two categories.
Statement of Equity. A statement of equity tells you the value of your business and how it changes from year to year. This is what your business is worth.
Now one important thing to remember is that the specified period or twelve month period I mention above is not always January to December. In most cases it is for small business owners but not always. This twelve month period is based on how your business entity was established. So check you incorporating documents if you are unsure.
Do you know what your financial statements say about your business? What challenges do you have with reading your financial statements?
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