Making Friends with Your Numbers

This article was written by Walter Miller, owner of Norman Professional Services.

Are you intimidated by—or afraid of—the numbers side of your business? If so, you’re not alone.

Most people start small businesses because they have an idea, talent or skill to offer the world, and want to make money doing this. It’s easy to focus on the first part to the exclusion of the second. Of course that’s not a good strategy for building a profitable and sustainable business.

If you have hesitated about rolling up your sleeves and digging into the financial side of your company, or could use a good 10,000-foot review, then read on. What you find here will add years to the life your business—and make sense of the conversations you have with your accountant and other trusted advisors.

Let’s Start at the Very Beginning

When accountants refer to “financial statements,” they mean three different reports that combine to give you a complete picture of how your business is doing:

  • Income Statement
  • Balance Sheet
  • Statement of Cash Flows

Each report answers different questions about your business’ financial results and condition. That means each one serves a distinct purpose—so you need all three for a well-rounded and balanced look at how your business is performing. Here is what they can tell you.

Your Income Statement

Answers the question: How Profitable Is Your Business?

This is also called the profit and loss or P&L statement. That’s exactly what it tells you: if your business is making a profit or experiencing a loss. The income statement always covers a specific period of time: such as yesterday, last week, last month, last quarter, or last year. It’s based on one of the fundamental equations in accounting:

Gross Revenue – COGS – Operating Expenses = Net Income

As you can see, this report has three primary sections. At the top is Gross Revenue (also called sales or gross income). This number reports how many products you sold or services you delivered. When business owners say they are growing their “top line,” they mean this number is getting larger.

Next is the Cost of Goods Sold (or COGS) section. In a service business, this section is often called the Cost of Sales. Either way, COGS refers to the expenses directly related to how your business makes money. You could not produce your product or offer your service without spending this money.

For example, if you sell granola, your COGS are the raw materials, such as oats and honey, and all the other delicious ingredients. COGS would also include your packaging costs, as well as the wages you pay to the workers who make the granola. In a service business, your primary COGS are the wages you pay to employees who do the work that you deliver and bill to your customers.

When you subtract your COGS expenses from your gross revenue, you have Gross Profit. If it is expressed as a percentage of gross revenue, it is called the Gross Profit Margin. Another way to describe gross profit – it is the money left over after all of the direct expenses (COGS) have been paid.

The third and final section of your income statement is Operating Expenses (also called indirect expenses). Examples include advertising, non-COGS employees, rent, telephones, insurance, utilities, and all the expenses necessary to keep the business operating.

If you subtract the operating expenses from the gross profit, you have your business’ Net Income. This is the famous “bottom line” people often mention. Net income is simply your revenue minus all direct and indirect expenses.

Balance Sheet

Answers the question: How Wealthy Is Your Business?

You could call the balance sheet “your wealth statement.” To understand why, we look at the fundamental accounting equation behind it:

Assets = Liabilities + Equity

Unlike the income statement, the balance sheet is a snapshot rather than a measurement over time. We literally pause your business and see where everything is at that moment in time. Here is a closer look at each section.

Assets are basically three things: your cash, your “stuff,” and the promises customers have made to pay you. Your stuff includes office furniture, computers, and any machines or equipment your business uses.

When you send your customers an invoice, they have made a promise to pay you later. Accountants call the total of all the invoices that customers owe you your accounts receivable. Your Liabilities are the promises you have made to pay other people—such as vendors and lenders. Another word for this is debt.

If we add up all the assets (cash + stuff + promises held) and we subtract your liabilities (promises you’ve made to others) we’re left with your equity. Equity is how much of the business you own. Put another way, equity is the wealth you have built up in your business. This is what you get to keep after all the dust settles between what customers owe you, and you pay what you owe.

Cash Flow Statement

Answers the question: How Much Cash Money Is Your Business Producing?

This is the final leg of the three-legged financial information stool. It connects the income statement and the balance sheet. It also answers the common business owner’s question, “If my income statement shows so much profit, how come there’s no cash in the bank?” Like the income statement, it covers a specific period of time: usually weeks, months, quarters or years.

It’s called cash flow because accountants see three different ways that cash can enter and leave your business:

  • Cash from Operations: If we collect a ton of money from our accounts receivable, that would be an example of cash flowing in from operations.
  • Cash from Financing: When we pay our loans, the principal payments to the lender are an example of cash flowing out from financing.
  • Cash from investments: When a small business owner takes a draw or dividend (not salary) out of the business, that constitutes cash flowing out from investments.

That creates this equation supporting the cash flow statement:

Net Income +/- Cash from Operations +/– Cash from Financing +/– Cash from Investing = Cash in the Bank

What It All Means

When combined, these reports answer this set of critical business performance questions;

  • The income statement answers – “Does my business model generate a profit?”
  • The balance sheet answers – “What’s the return on my investment of time, money and entrepreneurial risk?”
  • The statement of cash flows answers – “Is my business converting its profits into actual cash?”

Taken together, the three financial statements help business owners know where they are on the path toward building a sustainable and profitable business.

That means making friends with your numbers helps you know what to look for when in conversations with your business about your business. They aren’t there to judge you for what you did or didn’t do well or not. They’re only there to help you make better decisions—and what business owner doesn’t want to do that?

Key Ideas

  1. Ask your accountant or bookkeeper to generate the three financial statements and review them with you. Ask plenty of questions. Remember when learning your business’ language – numbers – the only dumb question is the one you don’t ask.
  2. Set a monthly or at most, quarterly appointment with your accountant and trusted advisors to review your business’ performance starting with a thorough review and conversation about the three financial statements described here.
  3. When reviewing the numbers of your business, start asking yourself and others in the business the why’s and how’s of the numbers. How did the numbers happen? What do the numbers mean relative to our overall goals and objectives this year?
  4. Don’t review the three financial statements alone. At the very least, review them with your accountant or someone who is conversant with the three foundational reports. Consider that each time you review them, you are becoming more fluent in speaking the numbers of your business.
  5. Keep this SBOM section handy and available for your frequent review while you’re gaining greater fluency and comfort with your business’ numbers. After a while, it will be second nature to you, but in the beginning use this section as a friendly reminder tool as you use these three report tools.