As I said last week, it is really important to know your numbers in your Business. I want to make clear that there are 3 different Financial Statements that have 3 different purposes. They are listed in the title, but for completeness: Income Statement, Balance Sheet, and Cash Flow Statement.
The most recognizeable of these statements is the Income Statement. The goal of the Income Statement is to define the Operating Business. This is where Revenue and Profit are defined. When you read an Income Statement, you are trying to discover if the company is making money on an ongoing basis. Now there are some types of businesses where this can be more complicated. For example, I have discussed Autodesk over the last couple of Sonoma County: News and Notes posts. They are in transition to a subscription style business from a point of sale business. This means that their Income Statement is a problematic at this time. But for most Businesses this is not an issue. The core of the Income Statement is to look at Revenue during a time period and deduct costs from it to arrive at Profit. When a company is public and they announce Earnings Per Share (EPS), they talking about taking their Profit and dividing it by the number of Shares outstanding in the company (Earnings divided by Shares or Earnings Per Share).
The Balance Sheet is different. The Balance Sheet is all about Assets and Liabilities. Let me use a classic Balance Sheet item – Long Term Debt. Let’s say you use a Loan to fund your business. You make loan payments every month. This impacts your bank accounts but is not really part of the day to day operation of your business. Your employees are not looking at the loan payments when they do their jobs. The Balance Sheet confuses people because it always balances. In all cases, Assets equals Liabilities. But the balance is based around something that is outside the real world. Assets are those things that the company has or is owed. For example, Accounts Receivable is an Asset. Liabilities are things that the company owes for example, Accounts Payable. What Balances the two sides is Shareholders Equity. This means that if a company has more Assets than Liabilities then the Shareholders have positive equity (they own something).
The Cash Flow Statement is even less well known but in many ways the most important. If you think of the Income Statement as being about your day to day business and the Balance Sheet as your Investment Accounts, then the Cash Flow Statement is all about the actual dollars in your wallet. There used to be a term that people would use to describe farmers: Land Poor. They had lots of assets: Land, Buildings, Animals, and Equipment. But none of that paid for anything directly. This is where the Cash Flow Statement comes in. The Cash Flow Statement combines all the factors of the Income Statement and Balance Sheet with Investing Activities to figure out the actual cash balance at a company.
So, there it is 3 different statements all with slightly different views of your company. We will be starting with the Income Statement and going from there. Our first topic will be Revenue!
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