30 December 2024

Why It’s Crucial for Small Business Owners to Grasp Financial Statements

By Ronald Smith

As a small business owner, understanding financial statements is absolutely essential. Let me tell you why.

Financial statements are like the crystal ball of your business. They unveil the story behind your finances, giving you a clear picture of how your business is doing. These statements consist of the balance sheet, income statement, and cash flow statement. Each of them provides unique insights into different aspects of your business.

The balance sheet, for instance, shows you what your business owns and what it owes. It’s like taking inventory of your business’s possessions and debts. By studying the balance sheet, you can see how much money your business has tied up in assets and how much it owes to creditors or suppliers. This information is crucial for making informed decisions about your business’s financial health and stability.

Next, we have the income statement. This statement gives you a summary of your business’s revenue, expenses, and net income over a specific period of time. It’s like putting together the pieces of a puzzle to see how much money your business is making and how much it’s spending. By analyzing the income statement, you can identify trends, track profitability, and make strategic adjustments to maximize your earnings.

Finally, we come to the cash flow statement. This statement tracks the inflows and outflows of cash in your business. It’s like keeping a close eye on the money coming in and going out of your pockets. By examining the cash flow statement, you can pinpoint potential cash shortages or surpluses, make informed decisions about financing or investment opportunities, and manage your business’s liquidity effectively.

Understanding financial statements is not just for accountants or finance professionals. It’s a crucial skill that all small business owners must possess. By comprehending these statements, you gain a deep understanding of your business’s financial position, enabling you to make informed decisions and steer your business towards success.

So, don’t let financial statements intimidate you. Embrace them as your secret weapon, empowering you with the knowledge and insight needed to thrive as a small business owner.

Why It's Crucial for Small Business Owners to Grasp Financial Statements

As a small business coach, one of the first things I like to talk about with my new clients is the financial statements. But sometimes, I get some pretty puzzling answers when I ask them what they think those statements are. It’s like they’re trying to solve a riddle!

One person said, It’s just a bunch of numbers on a piece of paper. Another thought it might be a tax return, while someone else mentioned a bank statement. And then there was the question about the balance sheet. Does that have something to do with it? And what about revenues? Are they part of the balance sheet, or do they belong somewhere else?

It’s understandable to be confused about all this financial stuff. But let me break it down for you. The financial statements are like a report card for your business. They show you all the important numbers that tell the story of how your business is doing.

One of those statements is the balance sheet. It’s kind of like a snapshot of your business’s financial health at a specific point in time. It shows you what your business owns (assets), what it owes (liabilities), and what’s left over for you (owner’s equity).

Then we have the income statement, which tells you how much money your business made and how much it spent during a certain period of time. This is where you’ll find those revenues and gross profits you were wondering about.

So, to sum it all up, the financial statements are not just some random numbers on paper or a mystery. They are a vital tool that helps you understand the financial health of your business. And as your coach, I’m here to help you make sense of it all, so you can take control of your business’s success. Let’s do this together!

After years of working closely with small business owners, I’ve noticed that most of them don’t use their financial statements to run their businesses. As a result, they often struggle to read or make sense of these statements. It’s heart-wrenching to see grown, strong individuals break down in tears when we ask them to explain what they see on their financial statements and what the numbers mean. Sadly, the majority of these business owners are completely lost when it comes to presenting the information on their financial statements. No one has ever taken the time to teach them. Most small business CPAs miss out on the chance to educate their clients about these numbers by not encouraging them to present the information themselves.

Many CPAs who specialize in small businesses believe they do a good job explaining the financial statements when they present their clients with tax returns or quarterly financial statements. However, as a business coach with a background in finance, I know that most small business owners still struggle to understand these statements. The brief summary they receive from their CPA during tax season doesn’t provide them with all the knowledge they need to comprehend and plan for their business throughout the year. Most business owners know they should be familiar with these numbers, and after being in business for a while, people assume that owners already understand them. Unfortunately, many owners are too ashamed to admit that they don’t comprehend their financial statements. That’s why, during our initial meeting with new clients, we ask them to present their financials to us. You can’t bluff your way through a presentation.

When I, as a small business owner, have a solid understanding of the financial statements, I not only know what they represent but also understand what they are telling me. This knowledge empowers me to take action and succeed intentionally. In fact, our business coaching clients define success as achieving growing and sustainable profits. Without sustained profits, you’ll eventually run out of cash and your business will cease to exist. So, understanding and interpreting the numbers is crucial for long-term success.

After coaching businesses for more than 15 years, I often find that my clients’ CPAs or financial advisors see me as a bothersome interference at first. This is because small business owners usually have a lot of questions they don’t have answers to. And when they turn to their CPA or financial person for guidance, they often get a response like, Why do you need to know that?

When faced with this situation, you can simply explain to your CPA that you’re working with a coach who expects you to have the answers. The key here is to break through the barriers of poor communication that often exist between CPAs and business owners. While the CPA may think communication is going great, the business owner is usually feeling frustrated. Trust me, it’s rare for one of our clients to speak highly of their CPA.

Why it’s Important to Understand Financial Statements

Understanding the financials is really important because it helps me, as the owner, do something super important for my business: create a plan to make a profit. You might have heard it called a budget, but budgets sometimes forget about a really important part, which is predicting how much I’ll sell, not just how much I’ll spend. It’s impossible to make a profit plan if I don’t understand the financial statements.

Alright, listen up, fellow business owners. The first thing I want you to do is understand those tricky numbers on your profit and loss and balance sheet. Trust me, once you wrap your head around them, projecting your future numbers won’t seem like such a big deal. It’s actually pretty cool because it gives you the power to plan out how your business is gonna make money in the next year. Imagine having a map that shows you exactly where your business is headed for the next 12 months. That might be hard to imagine for most of us, but guess what? It’s totally doable!

As an owner, I know we all have a certain amount of money we want to make each year. But you know, I was talking to a fellow business owner recently and it got me thinking. Sometimes, there’s a big difference between what we want and how to actually achieve it. So, I asked him what his goal was for this year. And you know what he said? Well, my goal is to make $100K in profit, just like I did last year. But when I went to the bank, the money wasn’t there. So, this year, I really want to see $100K in my bank account by the end of it all.

After I asked a few more questions, I was able to help him figure out where all the money went last year. They used it to pay off debts, build up inventory, pay taxes, and deal with clients who were late in paying, which resulted in a lot of money owed to them. So in order for him to end up with $100,000 in the bank next year, he would need to make a profit of around $250,000. I wish you could have seen how happy he was when he heard this. He had been struggling with this question for a long time, and now he finally had an answer!

If you create a good plan and stay focused, it can be really amazing and exciting to achieve your goals. As a small business owner, understanding your financial statements will help you take action and make things happen.

Running a company successfully isn’t as hard as some people think it is. The first step is understanding your numbers, which can make the whole process much simpler.

You don’t have to be an accountant or CPA to read a financial statement. But you do need to know and keep track of the numbers to run your company and achieve your profit goals.

Small business owners who reach out to coaches for help with financial statements experience a transformation. They become calm and excited because they gain confidence in their plan and running their business. Once they fully understand their business, they realize they have the power to guide it towards sustainability, success, and profitability. It’s truly empowering!