When I ask business owners about how things are going they generally say their profit and loss looks pretty good. The problem is that’s the only financial report that they look at and while it’s an important indicator on your business performance it doesn’t tell the whole story.
If you want to properly understand how your business is faring you need to look at three core financial reports:
- Profit & Loss – also known as profit & loss report, statement of profit & loss or income statement
- Balance Sheet – also known as a balance sheet report or statement of financial position
- Cash Flow – also known as a cash flow report or statement of cashflow
All three reports are actually related and while each one focuses on a different aspect of your financial situation they work together to help you understand the overall picture.
Below we discuss all three reports and find out the reasons why business owners and managers need to look at them regularly.
Profit & Loss
The Profit & Loss report shows your financial performance over a period of time. It is made of two core sections, your income (also called revenue) and expenses. Depending on the type of business you have your expenses might be split into two sub-sections, cost of goods sold and general expenses otherwise it will just be one section called expenses.
- Income/Revenue represents sales you have made
- Expenses represents costs you have incurred
- Cost of Goods Sold is a sub-type of expenses and is generally a type of expense when you sell physical goods
- Profit is calculated as Income less Expenses and will give you either a Net Profit or a Net Loss figure
While this report is good at telling you what your sales and expenses have been it doesn’t tell you everything about your business, for example it doesn’t tell you if you owe someone money. It also doesn’t necessarily tell you how much money is coming in and out of your bank account.
The Balance Sheet represents the current financial position of your business at a fixed point in time. It’s generally set out in three sections:
- Assets – This is anything that the business owns or is owed ie: your cash at the bank, furniture and equipment, sales you’ve made but haven’t been paid for yet
- Liabilities – This is anything that the business owes someone else ie: a loan to a bank, superannuation you haven’t paid yet, purchases you haven’t paid for
- Equity – This is the difference between Assets and Liabilities and represents the value to the owners
By understanding your Balance Sheet you can see what your current financial position is. For example generally if you have more assets than liabilities that would be a good position because it shows you have the capacity to pay off your debts while if your liabilities were higher than your assets you could have problems looming up ahead.
The Cash Flow report shows what money is coming in and out of a business over a period of time. A lot of people think that the Profit & Loss report shows how much money is coming in and out of the business. This is not necessarily correct depending on how your bookkeeping is set up ie: if you buy some goods but don’t pay for them it might show as an expense on your Profit & Loss but in actual fact the money hasn’t been paid out yet, the same would go for sales made but you haven’t received payment yet.
The Cash Flow report specifically only looks at what cash is coming in and out of your business irrespective of what sales and expenses are appearing on the Profit & Loss report.
There are many different Cash Flow report formats and they tend to vary depending on your bookkeeping software. Generally though it will show how much money you have at the beginning of the period, what money has come in, what has been spent and how much is at the end.
Bringing it all Together
By understanding not only how each report looks at a different aspect of your business but by also understanding how they work together you can get a much better understanding of where you are financially.
If you would like some help on better understanding your own business contact us today and we can show you how to get the most out of your bookkeeping.