When entrepreneurs launch their businesses, much of their time and energy are focused on day-to-day outward-facing operations like customer service, sales and inventory management. What’s equally important to long-term growth and success, though, is to have a thorough understanding of your business’s financials.
In this article, we look at the five most important financial documents that business owners need to create, understand and use to track and drive growth. When these financial documents are used together, they offer a full picture of your business’s overall health.
Here’s why these five financial documents are essential to small businesses
The five key documents include profit and loss statements, balance sheets, cash-flow statements, tax returns and aging reports. They help you ask the right questions and find answers that are particular to your business, such as:
- Whether your business revenue flows consistently or your sales and services are more cyclical
- If your business is profitable, barely breaking even or losing money
- Which items and services generate the most profit and which are loss leaders
These documents can help you develop smart, data-driven strategies for everything from staffing and inventory management to adding locations or mitigating losses. They help you see if, how and when it’s wise to invest in new equipment or take out a loan to cover tighter times. They also help you to be better prepared to apply for funding, add partners or investors.
Even better, these documents are available with your business’s bookkeeping software, or from your bookkeeper or certified public accountant (CPA).
1. Profit and loss (P&L) statement
A profit and loss (P&L) statement, also referred to as an income statement, is used to evaluate current financial condition and prospects for growth. A P&L summarizes business revenues generated and expenses incurred over a specific period of time. Whatever’s left after the expenses are deducted is profit, and if expenses exceed revenues, then your P&L shows a loss.
It’s common for many small businesses to show losses at various times, such as during launches and expansions. However, continuous losses are a “red flag” for business owners, because they indicate that more money is consistently going out than coming in. When you stay on top of your financials, you can find these issues early on and address them more effectively.
2. Cash flow statement
An often-quoted statistic shows the importance of maintaining strong cash flow: 82% of the small businesses that fail do so because of cash flow problems. Regularly examining your cash flow statement can go a long way in helping your business to stay on the positive side of that statistic.
While a P&L simply shows money in and money out for a specific time, the cash flow statement is more like a budget, used to forecast revenue in and expenses out over a time period – often, about three years. For your business to operate effectively, you have fixed and variable costs that have to be paid from the money your business generates (in addition to bank loans, taxes and the purchases of new assets, if needed). The cash flow statement shows whether or not a business is able to do this sufficiently.
Cash flow statements help business owners plan day-to-day and long-term investments and provide owners, lenders and investors with the business’s cash position.
3. Balance sheet
Your business’s balance sheet helps you track your business’s growth.
Like P&Ls, balance sheets show how your business is doing at a particular point in time – quarter by quarter or year to year, for example. Unlike P&Ls, though, your balance sheet provides a snapshot equation of your business’s assets, stated as business liabilities plus owner equity.
Assets can include short-term assets, such as money in the business checking account and inventory that you expect to turn around quickly. Long-term assets include real estate and major equipment. Similarly, liabilities are made up of short-term debts like costs for producing current goods and long-term debts, such as business loans. Equity includes cash invested by the owner or investors and retained earnings.
4. Tax returns
Most business owners are familiar with tax returns before they even open businesses, because they’ve filed them as individuals. When you run a business, it’s critical to keep up with your business taxes, as well as any personal taxes that you may be liable for separately.
The tax form you file will depend on your business-entity type, and there are different income tax consequences that apply to each. Often, businesses use CPAs or other tax professionals to file their taxes. It’s important that you review yours, because it can help you and your financial team create growth strategies that can be advantageous to your business. These include when to hire staff, buy equipment or expand to new locations.
5. Accounts receivable/accounts payable (aka, “aging reports”)
An aging report categorizes debts owed to the business, including the length of time the debt is owed. “Accounts receivable” is the accounting term for funds that are owed to your business, while “accounts payable” are the funds that your business owes to others. In business, it’s generally thought that the older a debt is, the lower the probability that it will be paid. If a business doesn’t get paid, it loses money and can have an unhealthy cash flow.
Aging reports help you see how many accounts receivable are overdue and how old they are, so that you can follow up and take action to bring money in. Conversely, if you have bills that are overdue, this should signal that you need to get caught up. Talk to your CPA and financial team about how to better manage expenses and streamline operations.
Use your business’s financial documents to drive growth and success
With updated and accurate financial documents in hand, you can easily find growth opportunities that are ready to be leveraged, and spot issues that may be draining resources. Additionally, thoroughly understanding and maintaining these documents prepares you for critical conversations with potential lenders and investors.
