Introduction
Many business owners take a massive leap of faith to start their businesses, following their passion to create something meaningful. However, as they progress, they often neglect their financials or struggle to understand them.
"I see it every day where a business owner has taken a massive leap of faith to start a business… but the further they go, the less they actually pay attention to their financials."
This article aims to provide an asset for education, helping business owners interpret their financials without incurring high costs. By extending your financial literacy, you can make better strategic decisions for your business.
The Three Essential Financial Statements
Profit & Loss Statement (P&L)
The P&L statement is crucial in understanding revenue, costs, and profitability. It consists of:
- Revenue
- Cost of Goods Sold (COGS)
- Gross Profit
- Expenses
- Net Income
"When you think about your P&L statement, we’re looking at revenue, cost of goods sold, gross profit, expenses, and net income. There’s so much here that can drive an understanding of how you’re actually generating revenue."
Balance Sheet
A balance sheet provides a snapshot of what your business owns versus what it owes. It consists of:
- Assets
- Liabilities
- Equity
"The balance sheet gives a bigger picture snapshot of what the business owns versus what it owes."
Statement of Cash Flows
This statement is often overlooked because it can be difficult to interpret, but it reflects the financial pulse of a business.
"The cash flow statement is the financial pulse of the business, but it’s often ignored because, quite honestly, it’s hard to read."
Avoiding the ‘Bank Balance’ Mindset
Many business owners manage their finances by simply checking their bank balance.
"What we see so much is that business owners are managing their business finances based on looking at their bank balances—‘Do we have enough cash to pay the bills? Great!’ But it doesn’t tell the full picture."
Instead, business owners should analyze their financial statements to understand how cash moves in and out of the business.
Using the P&L for Strategic Insights
A P&L statement provides essential information for decision-making. Owners should use it to identify trends:
- Is revenue growing but cash declining?
- Is there enough margin to justify hiring?
- Can sales and marketing investments be expanded?
"The P&L is a great place to start digging into trend-based insights—how you’re actually investing dollars to create momentum for your business."
Understanding Pricing Strategies Through the P&L
Margins and pricing strategies play a critical role in financial sustainability.
"Do the margins that you have actually drive sustainability for your business? Do you understand what your margin is?"
In inventory-based businesses using cash accounting, financial statements can reflect dramatic swings in profitability when large purchases are made. This can make financial health appear inconsistent if not properly analyzed.
The Role of Financials in External Stakeholder Relationships
Your P&L and balance sheet are essential for investors and lenders.
"Lenders may specifically be looking at your balance sheet and liquidity, but the P&L is a good representation of whether you’re moving in the right direction."
If owners only assess revenue without considering profitability and cash flow, they may misinterpret their business performance.
Making Financial Analysis a Habit
Many businesses rely on financials only at tax time instead of making financial analysis a routine.
"Most often, owners are looking at revenue without assessing profitability, confusing the health of the business with cash flow because they only look at financials once a year."
To avoid this mistake, owners should:
- Review P&L and balance sheets monthly
- Identify trends instead of looking at single numbers
- Compare cash flow trends to revenue generation
Actionable Steps to Improve Financial Analysis
To get started, business owners should:
- Review a three-month balance sheet – Compare trends in cash flow and revenue.
- Analyze profitability vs. expenses – Look at sales and marketing costs relative to revenue.
- Differentiate between cash and accrual accounting – Understand how each impacts financial statements.
"As a quick action point, take a look at a three-month balance sheet in QuickBooks and compare your cash balance to your P&L over the last 90 days."
Conclusion
Your financial statements should serve as a real-time GPS for decision-making, not just a compliance tool. By using them consistently, business owners can gain deeper insights into financial health and improve strategic decision-making.
"Your financial statements should be a guide for your business strategy—not just sitting in a folder or used for tax compliance."
By developing strong financial literacy, SMBs can create a foundation for sustained growth and profitability.
