Have you ever felt like you are getting sucked into a black hole when you look at your finances? Or maybe you feel like a ship passing through the Bermuda triangle, just bound to end up lost…
You know that understanding your numbers in your business is vitally important, but you just can’t seem to get your head around it. As the owner of a business coaching company, I often come across business owners who don’t understand how to interpret their financial reporting in their business.
Well, here’s the good news… It’s not as hard as you think…
Forget about P&L’s, cash flow statements and balance sheets for a second. Think about driving along the freeway at night time and the dash board of your car goes out. Everything just stops working, what are you going to do? Of course you’re going to pull over and try and get it fixed.
Yet how many business owners are driving their business without the dashboard working? It’s pretty alarming when you think about it. But it’s also understandable. Many accountants are great at what they do, however they (like any industry professionals) tend to speak in accounting jargon rather than plain English. This can get a little bit confusing when they talk to business owners like myself. In fact, when I started my business, I was so confused with the finances that I called it the Bermuda triangle of business because I kept getting lost!
When it comes to finances, there are three things that every business owner should understand; the Profit and Loss Statement, the Balance Sheet and the Cash Flow Forecast. Notice that I didn't mention the bank balance. Judging the performance of your business on your bank balance alone can be dangerous. However, this is how a lot of business decisions are made.
So, let’s look at each of the three areas and understand what they are and how they work together. First of all, your Profit and Loss statement is like a scorecard. Your P&L is like a lap board if you’re in a race car, it shows you how fast you went at the end of each lap. Did you know that you can actually be showing a profit on your Profit and Loss statement and have no money in the bank? Companies have gone broke showing a profit on their P&L.
Your cash flow forecast is like the fuel in your engine. It shows you how much fuel you have in your tank, or in other words, how much money you have in the bank. It also shows you how much fuel (money) you can expect to have in the next 30, 60 or 90 days. If you are on top of your cash flow forecast, you won’t run out of money unexpectedly.
So you’re probably wondering how you can have profit on your Profit and Loss Statement and still run out of money. Well, a there are a lot of things that go on the cash flow forecast don’t show up on the P&L, for example, the lease payment on a vehicle. Say you've got a van that you drive around for your business. That van’s lease payment won’t necessarily show up on your Profit and Loss statement because there are two parts to a lease, there’s principle and there is interest. The interest is an expense where the principle is not an expense so it doesn't show up on your P&L.
Now, depending on the particular financial package you've taken, some leases or purchases are slightly different in the way that you can claim the deduction. So there will always be some things in your business that won’t show up on your P&L. They will show on your cash flow statement as cash out but they don’t go on the P&L.
This leads me to the third side of the Bermuda Triangle… the balance sheet. The balance sheet is like your scorecard for the entire year. It shows you the overall health of your business. It’s not a report that you look at very often, but it is important because it shows you what your retained earnings are and what your equity is. So, what exactly is equity? Equity is all of your assets minus all of your liabilities. The bigger your equity, the healthier your business is!
I honestly can’t stress enough how important it is to know all three parts of the Bermuda triangle of finance. If you don’t have a good grasp of your P&L, cash flow statement and balance sheet and how they correlate, it is vital that you speak to someone who can explain it to you in simple terms.