Finance Statements: What They Are and How to Use Them, Explained in the Simplest Terms
The Profit and Loss Statement (P&L) is the bare-bones financial statement. This profit and loss statement details whether or not the business made money during the specified time frame. The second report is called a Balance Report or Statement of Financial Position. It provides a snapshot of the estate’s assets, debts, and beneficiaries. The third element is Cash Flow, which describes the business’s monetary inflow and outflow.
These issues are addressed in the Financial Statements.
Are we making money? That depends on the P&L.
Do we have a positive net worth?
Managing Money: Can we pay our bills?
If you are short on time and can only afford to educate yourself in a narrow area of money, make it cash flow. This is the primary financial instrument for calculating the necessary external funding. By “external requirements,” I mean that your business has monetary demands not met by its current revenue.
Money made and lost (P &L)
Earnings or a profit and loss account. The P&L is meant to provide insight into the potential for creating money. The simplest explanation is that you must make more money than you spend. While there are complex methods for assessing a company’s P&L, we’ll use a simplified version here because product or service sales are our focus.
Profit and Loss Statements: A Primer
Gross Profit Equals Operational Income – Direct Expenses.
Net Profit = Gross Profit – Secondary Expenses + Other Revenues.
Profit/Loss Equals Net Income – Taxes
In a perfect world, your business makes a profit and distributes the proceeds to various stakeholders, including workers, vendors, owners, financiers, and even the government. You can create an income statement with the assistance of any number of software programs. However, the business world is not a spreadsheet; instead, it is a set of interconnected logical and irrational decisions over that you have control over precisely one. The conventional wisdom holds that a business should never profit by selling a product or service for less than it costs. Nope, not going to happen. YouTube, the video-sharing website, does not benefit from video storage and distribution but from advertising revenue generated by the videos. Neither does Google, which offers a service of immense worth (searching the web) at no cost to its users. Internet access providers gain from this arrangement; Google does not treat them as consumers or customers, but as stakeholders.
It’s utopian to believe that every business can succeed like Google. Most companies must convince customers that they can give superior value compared to alternatives.
Most businesses consider gross margin, net margin or profit, and net profit as the three components of a revenue statement.
Gross margin is the outcome of the business’s activities.
Sales or other income generated by the organization’s core operations must be subtracted from selling-related costs. Spread the costs and prices of your various offerings across multiple sheets. You can compare their profitability in this manner. You’ll also see that it’s possible to lose money on some products while making a profit on others by selling more of them. Remember to factor in the time spent trying to close a transaction and the money lost (this time is also part of the direct cost).
Subtract the direct expenses from the total sales revenue to determine the gross margin. Include those that have been sold and shipped but not yet collected. Also, think about your fixed management costs (indirect costs) that don’t change, like your sales. Include the fees you have not yet covered, just as you did before.
Lastly, factor in the taxes and expenditures related to debt, such as interest on a loan and depreciation and amortization of machinery, equipment, and other assets. Profit or loss can be calculated by deducting these outlays.
The profit and loss statement is adjusted in several ways that vary from one company model to the next. Check with an accountant or other accounting specialist who can shed light on the specifics of this model to ensure accuracy. It would be helpful if you could elaborate on the estimates you made regarding your clientele, income, and expenditures. Getting customers will take longer than anticipated; I can’t say by how much. I’m also curious to see if the company is gaining new customers or offering more to the ones they already have. The number of customers, typical order value, and the impact of any discounts, credits, or installment plans should all be considered. If you’re starting a business or expanding an existing one, knowing these assumptions will help you greatly in pursuing funding and implementing your strategy. Online, you can find a wide variety of sample revenue statements.
The balance statement is up next. Assets, obligations (debt), and equity are the three main components of a company’s balance sheet. Because assets must be equivalent to the sum of liabilities plus equity, this financial statement is called a Balance Sheet.
Everything a business possesses that can be sold for money is considered an asset. That’s the traditional approach to business. The distinction between turning assets into cash and turning them into income is crucial to a business’s health. Actively producing revenue is a characteristic of assets. The funds in the bank, the chair, the trademark, the inventory, and the invention are all examples of things that require action on our part. If an asset’s only worth is its ability to be converted into cash, then it is not serving its intended purpose of generating wealth.
It is possible to classify assets as either “tangible” or “intangible,” depending on whether or not external sources establish their worth, or as “short-term” or “long-term,” depending on how quickly they can be converted into cash. Intangible assets include a company’s online presence, logo, brand awareness, partnerships with suppliers or customers, and intellectual property (patents, trademarks, and expertise), while tangible assets include furniture, computers, and vehicles. If the company is short on cash, it can liquidate its short-term holdings fast, but it will be unable to do so with its long-term investments.
The value of loans, unpaid bills, and employee salaries all fall under the category of liabilities (debts) owed by the business. Penalties can be either short-term or long-term. Short-term obligations are those with a maturity date of one year or less. Debts with a maturity greater than one year are considered long-term.
Equity represents a company’s ownership stake and can be liquidated more or less quickly based on local regulations. Businesses can be classified as either “people-based” or “capital-based.” It’s more challenging to sell equity in people-based companies because the company’s name is closely associated with its founders. For instance, a law firm, medical practice, a consulting firm, or beauty parlor would be worthless if its owners had a poor image. Like big law firms, quality control can
sometimes go beyond this impression. Most countries’ laws restrict the influence of capital in favor of the power of people’s choices, and equity in people-based firms is more commonly known as participation. In people-based businesses, changes in control are typically accepted with unanimity. Equity, also known as stock or shares, is the ownership stake in a business that determines its value rather than the talent or efforts of its employees. A group of people who may or may not be connected to the owners who run the business. These businesses make it simple for investors to buy and trade “shares” of ownership in the company. Such stock may be sold on a stock exchange.
Public businesses are those whose shares are traded on a public exchange. Private companies are those whose stock is not freely traded on public markets. Management decision-making in public businesses is constrained by rules that must be met. Shareholders are the owners of a company and are represented on the board of directors whether the company is privately or publicly owned. The board of directors determines the business plan. When people engage in the stock market, they anticipate two types of returns: appreciation in value (capital appreciation or depreciation) and dividend payments. The assets that create wealth can be financed by debt or equity, which can be seen in the balance sheet. The funding piece delves into how debt and equity financing work.
A Guide to Reading Your Financial Sheet
Income is produced by assets.
Debts (or liabilities) give rise to responsibilities.
Profits are created by equity (property).
Equilibrium between total assets (short-term and long-term), total obligations (short-term and long-term), and equity equals 100%.
This novel and valuable perspective on your Balance Sheet can make all the difference when you aim to amass money.
“cash flow” refers only to the monetary inflow and outflow of a company, group, or individual. Even if a company is making money (as shown on the revenue statement) and adding value (as shown on the balance sheet), it may fail if it doesn’t have enough cash to meet its financial obligations, making knowledge of its cash flow crucial. The effects of late payments are often understated, as are the benefits of debt, the required level of expenditure, and the wisdom of taking on debt.
What you need to know about Financial Flow
Sales, interest, refunds, and other revenue are all examples of incoming funds.
All payments made to vendors, rent, salaries, commissions, utilities, any other cost, debt repayments, prepayments, and other expenses, whether necessary or not, are examples of outflows.
To determine how much money must be invested (whether in the form of debt or equity), we must first determine how much money is needed to cover the accumulated shortfall that results when incoming funds are insufficient to cover outgoing expenditures. Typically, a ten percent buffer is built into the budget for miscellaneous costs.
An organization’s cash flow is defined as its net cash inflow less its net cash outflow. A negative cash flow necessitates an investment or capital contribution, which can be made by issuing a new payment requirement (debt) or selling a portion of the company’s assets (equity). Cash flow forecasting enables budgetary preparation for negative cash flow, necessitating additional funding. That is the cornerstone of financing.
Many businesses I’m familiar with have gone under because upper management ignored warning signs of a cash flow crisis until it was too late. Forecasting and verifying cash movements are essential. Understand the difference between projected and actual cash flow if you handle or want to manage a business or nonprofit. Proactive rather than reactive is the best method to maintain a balanced life and sound financial plan.
Alicia Castillo Holley is recognized worldwide as an authority on the wealth-building methodology known as Wealthing (TM). She has raised millions of money, launched nine profitable businesses, and educated thousands of employees. She has a global reputation as a lecturer and trainer, and she does so twice yearly.