The Big 3 of Business Finance

Your small business needs a financial check-up.

With the advent of online marketing, it’s become a habit assess the success of a business by monitoring website analytics, social media stats, or conversion rates.

But in his post, “How Healthy Is Your Small Business?”, Martin Kamenski reminds us to examine the financial health of our business, at least once every three months.

Martin notes that measuring financial performance by revenue you generate or by your bank account balance is not enough.

There are a few main financial statements that will give you a more accurate overview of your financial history, present condition, and sustainability for the future. These are The Big 3 of Business Finance:

1. Income Statement 

Also known as Profit & Loss. This report shows sales, cost of sales, gross margin, operating expenses, and profits or losses.  In other words, the flow of transactions over a certain period of time. Tim Berry, business planning expert, does the math:

Sales – Cost of Sales = Gross Margin
Gross Margin – Operating Expenses = EBIT (sometimes called ‘gross profit’)
EBIT – Interest – Taxes = Net Profit.

When it’s accounting for actual results, it’s called a statement. When it’s in a business plan, it’s called a projection, or a pro-forma statement, as in Pro-forma Income or Projected Income.

2. Balance Sheet

This is your business’s financial position on a specific date. There’s a fixed formula for this:

Assets = Liabilities + Capital 

Assets: everything your company owns; this could be inventory, land, buildings, furniture, vehicles, patents, accounts receivable… anything of monetary value.
Liabilities: what your business owes, such as debt, loans to be repaid, credit card balances, etc.
Capital (also called equity): ownership, investments, stock, and accumulation of earnings. 

3. Statement of Cash Flows 

Martin says that the statement of cash flows explains all the non-income statement ways that your bank account balance is affected. Tim narrows this down:

“It is important to distinguish cash flow, which is the change in the balance, from cash or cash balance, which is the resulting ending balance… cash flow is an assessment and understanding of cash coming into and flowing out of the venture in specific periods of time. This can be based on projections or actual cash flow.”

It’s important to distinguish cash flow from profits (the latter is sales minus costs & expenses). The cash flow statement also has a fundamental principle:

Ending Cash = Starting Cash + Money Received – Money Spent 

Understanding cash flow can be tricky. To make things simpler and to understand the concept, you can create a basic cash flow plan.

And in this case, as with Profit and Loss, the Cash Flow Statement shows actual results, and Projected or Pro-forma Cash flow shows estimated future cash flow.

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