No matter how promising your startup or company is, not having a sound financial understanding of it is a risky business. Yes, you could leave the finance to the bookkeepers and accountants, but you need to understand the underlying financial flows of your business, because that’s the key to understand how to manage your business successfully.
Knowing your company’s finance should give you as broad information about where your business is headed to, as well as specific information such as: how much you should spend on a marketing project; would such investment be profitable, etc. The financial tools that we review in our articles and our models will help you to manage your day-to-day business and most importantly will help you to build a sound plan for the future of your company.
Preparing a budget for your company and monitoring your performance through your monthly financial statements will help you to understand what has happened in your company, what is happening, and what you could expect will happen in your company. Yes, these tools are based on the Balance Sheet, Income Statement and Cash Flow Statement, which at first glance appear sophisticated. But very often startup’s and small business’ financial statements are not too complex and understanding them beyond the accounting terminology will actually give you the confidence that you understand your business better. Considering all the variables, that your business will face, you need every tool possible to manage these variables and financial knowledge is one of the most powerful tools for that.
So let us review quickly simplified versions of the three financial statement reports that are the foundation on which the financial planning and analysis is based.
The balance sheet is the foundation of the company
It is a financial picture of the company at any given time. It consists of the assets, liabilities and the shareholders equity of the company. Assets should equal liabilities plus shareholder equity, hence the name of it – balance sheet.
The income statement and the cash flow statement encompass the processes in the company
The Income statement is giving information about the profitability of the company. At the top of the income statements is the sales revenue. Below sales revenue is the cost of sales – the costs that incur to make the products. After that comes operating expenditures part – the costs needed for supporting the operations of the business. Your sales less the expenses (costs of sales and operating expenses) equals the operating profit of the company. The operating profit less the corporate taxes gives the net profit of the company.
The cash flow statement is showing how much cash is generated by the company’s activities. The net income from the income statement adjusted with the receivables from customers and payables to suppliers represents the cash flow from operations. When you subtract from your cash flow from operations capital expenditures and adjust for financing activities you get your net cash. That net cash flows to the balance sheet cash line and this is how the three separate statements tie up all together at the end.
Planning and tracking your company’s financial results
After getting familiar with these essential financial processes in your company, you are able to build your operational plan for them as well – a goal set mostly for your business’s profitability and generated cash. Of course you could not predict exactly the future, but having a budget prepared is essential in order to be able set goals for your business. Then when some variables from your plan do not develop as forecasted, you should be able to take corrective actions and stay on track to your targets.
This is where monitoring and analyzing your performance come into the picture. Using your monthly financial reports, you should be able to track your forecast achievements. For example if your operating income is not at the forecasted level, you could correct that with some cost saving to get back to your income target. Furthermore if you are missing your income target due to lower sales, you could analyze one or more of the following scenarios:
- which is the product causing it;
- is the reason due to higher product costs or due lower sales volumes;
- could you increase the price or the volumes sold of your other products, etc.
The better your financial understanding of your business is, the better you are at managing all the uncertainties while following your budget. This task is a lot easier when you have the right planning and analysis models at your disposal!
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