D. R. James Consulting, LLC

Most business owners I meet have seen their financial statements. Far fewer feel that the statements are speaking to them. That is not a reflection on the owner — it is a reflection on how rarely anyone sits down and explains what each report is for.

There are three, and each answers a different question.

The Profit and Loss Statement

Also called the income statement. It answers: over a period of time, did the business earn more than it spent?

It starts with revenue, subtracts the direct costs of delivering your work, and gives you gross profit. From there it subtracts your operating expenses — rent, software, insurance, advertising, professional fees — and arrives at net profit.

The single most useful habit with a profit and loss statement is to stop reading it as one number. Read it as a shape. Compare this month to the same month last year. Compare your expense categories to each other. A category that has quietly doubled is far more informative than the bottom line, because it is something you can act on.

The Balance Sheet

It answers a different question: at one moment in time, what does the business own and what does it owe?

Assets on one side — the cash in the bank, the money customers still owe you, equipment. Liabilities on the other — credit cards, loans, sales tax and payroll tax you have collected but not yet remitted. What is left over is your equity.

The balance sheet is where the problems a profit and loss statement can hide come into view. A profitable business with a large and ageing accounts receivable balance is a business that is working hard for money it has not been paid.

The Cash Flow Statement

It answers: where did the cash actually go?

Profit and cash are not the same thing, and the gap between them is where most small businesses get into trouble. Buying equipment takes cash without reducing profit. Paying down a loan takes cash without reducing profit. Invoicing a customer creates profit without producing any cash at all until they pay.

Reading Them Together

Any one statement on its own can mislead you. Read together, they tell a complete story:

• The profit and loss statement tells you whether the work you are doing is worth doing.
• The balance sheet tells you how strong the business is right now.
• The cash flow statement tells you whether you can meet next month’s obligations.

A Few Things Worth Checking Every Month

• Does the cash balance on the balance sheet match your actual bank balance? If it does not, the books have not been reconciled, and nothing above it can be trusted.
• Is anything sitting in an “uncategorized” or “ask my accountant” account? Those are unanswered questions, and they distort every report they touch.
• Are owner draws being recorded as draws, rather than as business expenses? Mixing the two overstates your costs and understates your profit.
• How much of your receivable balance is more than sixty days old?

You do not need to become an accountant to run your business well. You do need your statements to be accurate, current, and explained to you in plain language — often enough that the numbers stop being a surprise and start being a tool.