How do you manage your company’s finances? Through your check register or online bank statement? Do you have a bookkeeper, or do you manage the finances yourself? These are just some of the questions you should be thinking about when looking to make better financial decisions about your business.
When you are first getting started you may not understand the importance of having good accounting practices. Maybe you buy all your material on a credit card, throw all your receipts in a shoebox and as payments come in pay down the balance on the credit card. Then at the end of the year you turn the credit card statements and shoebox over to your accountant and they tell you if you made any money for the year. While this may be an extreme case it isn’t too far off from real life for some contractors.
By having sound accounting practices whether inhouse or through a bookkeeping service you will be able to have a better picture and more control of your financial situation. Through financial statements, you get a snapshot of the financial health of your business. Are you making or losing money? How are is your company doing compared to last year? Where should you be looking to save money?
There are three key financial statements every contractor should have and understand.
The first is the balance sheet which is a snapshot in time expressing the relationship of the company’s assets, liabilities, and owner’s equity. The formula used in the balance sheet is assets equals liabilities minus the owner’s equity. This formula can be modified to express the owner’s equity in the business by setting equity to assets minus liabilities. It is important to remember that the balance sheet represents a single point in time whereas the following statements represent a period of time.
The second is the income statement or sometimes called the profit and loss statement (P&L). At the most basic level, the income statement shows you whether or not your business is profitable. The money coming in (revenue), minus the money going out (expenses) equals the profit or loss for the company for a given period of time. Of course, if the value is positive you have made a profit if the value is negative you have lost money.
Cash Flow Statement
The third is the cash flow statement it is used to show the flow of cash in and out of the business. This statement can be used as a picture of the short-term vitality of the company or stated another way do you have the cash to pay your bills. The cash flow statement uses information gathered from both the income statement and balance sheet to calculate the positive or negative flow of cash from the business over a period of time.
By truly understanding the information shown in each of these financial reports you as the business owner can make more sound financial decisions. For most new business owners financial literacy is not common sense. This is why it is important to seek out knowledgeable partners that can help you read, understand and make informed decisions from these financial statements. A good starting place to learn more about reading and understanding your company’s financial statements is to ask your accountant for help.