Reading Financial Statements: Chart of Accounts

The chart of accounts is the index of all the financial accounts in your business. It’s an organizational tool that when set up right can lend itself to great reporting. It can be an amazing tool that tells the story of what’s going on in your business operationally.

Your numbers tell a story about what happened during the week, the month, the year, whatever time frame you’re looking at – and the chart of accounts is the foundational starting point.

So what does it do?

It basically provides a way for your financial transactions to find their way to the right place on your financial statements. That’s huge for a business owner, because with a well-organized chart of accounts, you can look at your reports and make sense of them.

Sensible reporting leads to insightful reports, and it gives you the data that allows you to make good decisions that take your business where you want it to be.

The chart of accounts shows your:

• Assets
• Liabilities
• Equity
• Revenue
• Expenditures

Some of those are balance sheet accounts and some are income statement accounts. Together, they are the foundational elements that allow for all of the reporting in your business.

If you’re thinking, “oh, I use QuickBooks” – all of that is driven by your chart of accounts. If your chart of accounts is a mess (or you’re using accounts inconsistently), you’re going to have problems. Sure, QuickBooks will choose a chart of accounts template for you when you first set up, but that doesn’t mean that it is going to support you as your business grows and changes. Consistent and proper accounting of transactions month in and month out is one of the critical keys here.

Ask yourself: are you measuring things that are important to you in these reports? We need to be paying attention to those numbers so we can make good decisions to affect them how we want to affect them. Without up-to-date and accurate measurements of what matters, you’re not going to be able to make the decisions you need to be making as a business owner in the frequency you need to be making them.

Bottom line: the chart of accounts is the fundamental framework that every other report in your business from the accounting software side is based on. So you want to make sure it’s organized in a way that’s conducive to getting you the information you need at the level you need it!

Reading Financial Statements: Balance Sheet

The balance sheet is one of your “Big Three” financial statements. What does the balance look like, how do we read it, and what does it really tell us?

The biggest benefit of the balance sheet is that it goes back to Day One of your business. It’s the only financial statement that goes back to the inception of your business, so it includes a ton of rich history. If your balance sheet is correctly stated, then chances are so are your income statement and statement of cash flows.

We can look at the balance sheet on a monthly basis for trends. What are we looking for? We can look at changes from the prior month for many different metrics – like inventory, accounts receivables, and accounts payables. You can also look quarter to quarter and year over year to get a sense of what’s going on from a cumulative standpoint and how we’re managing resources over time.

The balance sheet is broken down between three areas:

• Assets – what we own.
• Liabilities – what we owe.
• Equity – the difference between the two. This is the value of your business.

Internally, we use this information to manage our business. Externally, the balance sheet can be used by somebody who’s interested in buying your company or lending you money. They need to see the balance sheet to understand the financial health of your business and perform metrics like liquidity, profit, and debt to equity ratios.

Reading Financial Statements: Income Statement

As a business owner, you need to own your numbers and understand your numbers in order to make the best, data-driven decisions in your business. The income statement (also called the profit and loss or P&L statement) is where you keep score in your business. You’re keeping score of how your business is operating, and it’s a critical measure that goes hand in hand with the balance sheet. All of your results from your income statement flow through to your balance sheet.

The income statement summarizes all the income and expenses of your business over a given period of time. Monthly, quarterly, semi-annually, and annually are the standard periods of time. Those frequencies are relevant to your decision making in your business. You can look at these numbers compared to previous periods of time to get a lot of good information.

The income statement is really measuring the profitability of your business. We can also see some really helpful trends across time and different metrics like income and expenses. You get to look at those numbers and ask: why? Be curious. Understanding why your numbers change over time is one of the real benefits of your income statement.

We can also look at the income statement in relationship to historical performance from last year or expected performance in the form of our budget. Benchmark reporting can help us better understand how our operations are performing. Every month, we should be looking at some type of benchmark for comparison purposes even if you haven’t done a formal budget.

I love looking at the last twelve months report (LTM, or trailing twelve months TTM) on a rolling basis because that really tells a powerful and clear story. All together, this whole collection of reports tells the story of your performance. And when you know that, you can make wise and informed choices on how to move forward.

The buckets in an income statement include:

• Revenue
• Cost of goods sold
• Gross profit – the first subtotal we see, total revenue less cost of goods sold
• Expenses (overhead)
• Operating income – gross profit minus expenses

Understanding these numbers will keep returning to you over time what’s important, and how to manage it even better. It allows you to benchmark, do ratios, create projections, analyze your business and make decisions about how you can manage the business better to make more money and benefit employees, customers, stakeholders, and even your community.

Reading Financial Statements: Cash Flow

Your cash flow statement shows your business’ cash position and details what happened to your cash during whatever specified time period you’re looking at. It can be cumulative or it can be one period – typically, it coincides with your income statement reporting period. If you’re looking for answers on what happened during the month, then you’ll probably want to see the statement of cash flows for just the month. If you’re looking for what’s happened so far this year, then you’ll want to look at the year to date time period.

Remember: cash is king. We need to understand what’s going on with cash in our business so we can make excellent decisions that move the business forward. Not only do we need to know what happened in the rearview mirror, we also need to look at what’s going forward. We want to be able to project cash, as well.

Cash is the fuel of your business. If you’re in growth mode, you need cash to propel your business forward. You can invest in opportunities like advertising and fixed assets that can grow your business by leaps and bounds. Whatever your next step is, you need cash to fuel what’s next.

The cash flow statement gives you the ability to peek inside the details of what’s going on with your cash: where it’s coming from, where it’s going, how it breaks down.

The traditional layout for a cash flow statement includes:

• Operating activities – cash our operations are generating for us
• Investing activities – cash from the purchasing and selling of assets
• Financing activities – cash from debt financing and equity financing

If you have a software platform like Quickbooks, the big 3 financial reports including your cash flow statement are almost always included. You should be able to pull it up, hit run, and it will populate it. It’s nothing you need an accounting degree for.

TurboCharge Your Business is a show for business owners who are tired of just working IN the nuts and bolts of their businesses and ready to work ON the business itself from a big-picture, growth-oriented, strategic perspective. Explore more episodes here.