Ever pop into QuickBooks and it looks like the blackboard of your high school algebra class?
Numbers literally everywhere.
I know I know…you are a busy busy business owner and you want to get to the gold; the important information that tells you how you are doing.
That is the beauty of reports. They take all of your financial records and summarize them for you; typically in a one-page format, organized and ready for your review.
Running them is easy. I will show you how to run the three most important reports. However understanding them is an art, but I will show you what to look for.
Let’s get started.
1. PROFIT AND LOSS COMPARISON
The first report is the Profit and Loss Comparison. I like to run an income statement that compares your current results to either a budget or the prior year. Areas that need your attention jump right out at you and areas you’re excelling in provide reasons to celebrate or bestow praise on your employees.
If you don’t see this report when you click on the Reports button on your navigation bar (found on the left side of QuickBooks), Go to the “All Reports” tab and then click on the reports for “Business Overview”.
When you run it, you specify a date range to use. The most common are the current month-to-date and the current year-to-date. So if it is currently June 12, run the May 1 to May 31 and the January 1 to May 31 reports, since June is not over yet.
Below is an example from a test company showing the revenue section.
You can quickly see at the bottom that this company’s income is up 25.86% for the year. By scrolling through the list of the different categories of income you can see what the major contributors were; such as Design Income, Landscaping Services, Services, Fountains and Lighting and Services.
You can also see that categories like Plants and Soil and Pest Control Services were down compared to last year.
By reviewing this statement every month, you can get a jump on the trouble areas. In the example above, maybe they were not pushing their pest control services enough or maybe it was causing them to spend less time on their more profitable categories.
The same techniques can be used to review expenses. Here’s an example from the expense section.
Ideally expenses should grow at the same rate or slower than the revenue. So in this example, since revenue grew at 25%, expenses could also grow by 25% without causing an issue on their profits, but in this case expenses “decreased” by 40%.
It looks like job materials were down from the prior year from either fewer of these types of jobs, or better buying.
Here’s another example:
Expenses here are down 21.89% and were mainly due to professional costs for the first year of business. This was offset by higher equipment repairs from a (hopefully) one-time machine breakdown.
Here’s one last example:
Miscellaneous expenses are generally frowned upon. They give no clear direction on what they relate to. In this case, expenses in this category are way up over the prior year and should be looked at in more detail to see if they can be reclassed to a better account.
2. BALANCE SHEET
The balance sheet is another of the big three.
This one can also be intimidating. But if you break it down into sections, it is not too bad.
The first section is assets.
Think of these items as things your business owns, that are material and have future economic benefit. Materiality is different for each business, but for the small businesses I deal with, this is usually greater than $500. Assets can be current (held for less than one year) or long-term (held for more than one year).
As an example, something like a notebook is a thing your business owns and maybe it could be used for several years (not likely) but since it only cost $2 you would expense it rather than treat it as an asset. However a truck purchased for the business for $25,000 would be both material and used for several years, so it would be treated as an asset.
The most common items are: cash, investments, balances your customers owe you (accounts receivable), inventory (items purchased to resell) and furniture and equipment. There are others, but these are the most common.
Here’s an example:
Here we see that this sample business has total assets of $40,000 and this is a significant increase from the prior year.
The first thing to notice is that there was a nice increase in the bank accounts. This business is doing a better job of managing their cash flow then they were a year ago. If the cash accounts get too high, management will need to consider whether to invest this money where it can return more than a bank account.
The second point is that accounts receivables are down from last year. This could be due to several reasons: sales are down (not in this case), better collecting of customer balances due or changes in credit terms (requiring payment upfront).
Lastly, the business purchased a truck for $25,000 in the current year. Since it is material and will benefit the business for several years, it is treated as a long-term asset.
The next section is liabilities.
The next section is liabilities, which represents future outlays of cash, or what the business owes.
The most common items are: accounts payable (what the business owes vendors for products or services), taxes payable, accrued payroll and loans.
Like assets, liabilities can be short-term (less than one year) and long-term (over one year).
The most common ways to analyze this section is through a combination of comparing to a prior period (last month, a year ago) or using metrics, which we’ll talk about shortly.
Here’s an example from a sample company.
At first glance, what stands out is that debt is way up from a year ago, but that is because the business purchased a new truck and paid for it with a new loan.
Current liabilities are actually down compared to a year ago and is mainly in the credit card category where many start up expenses were paid for a year ago.
A common metric to use is to look at the current ratio or current assets divided by current liabilities. This shows the business’ ability to pay for liabilities that will need to be paid for in the coming year with assets that are relatively liquid.
For this company, the current ratio is 2.31 ($15,000 / $6500) and compares favorably to last year’s ratio of 1.28. The goal is to keep this number in the 1.2 to 2.0 range. Since this business is over 2.0, they should consider moving some of their assets into investments that pay a better return.
Another common metric is the debt to equity ratio which we’ll look at in the next section.
The last section is equities.
Think of equity as what is leftover of your assets after the debt is taken out.
The most common components are owner contributions (like stock), current profits or losses and prior earnings that have been reinvested in the company (retained earnings).
Below is the equity section from our sample company.
The equity total has increased by $6000 due to this year’s profits.
You can see that last year’s profits of $2500 were all plowed back into the company’s retained earnings.
A common metric to review is the debt to equity ratio. This is also important if you are trying to secure more debt, as the lender will want to see this number. A good ratio is to have the ratio be less than 1.0.
For this sample company, the debt to equity ratio is very high at 3.71 and this is about equal to last year’s 3.6 (also high). Management needs to generate more profits and use these to payoff its existing debt.
3. CASH FLOW STATEMENT
The last report is also one of the BIG 3 financial statements but it is seldom used or understood by most small business owners.
The cash flow statement shows how a business’ cash changed between two periods and then it shows how this change happened; where did the increase in cash from and where did the cash go.
Since cash is a vital asset to a business’ health, managing cash is important and this report can help you do that.
Let’s take a look at another example. The information on a cash flow statement comes from the balance sheet. Below is a sample balance sheet that compares the totals from this year to the totals from a year ago and shows the difference.
At the top of the balance, we see the two cash accounts called checking and savings. These two accounts increased by $3,817.47 over the year. Where did that extra cash come from? Well, that is what our cash flow statement will tell us.
If you look in the assets section towards the top, you can see that they increased by $13,495 from the purchase of a truck. Increases in an asset use cash. You need to pay for the truck and that will take cash.
Similarly, accounts receivable increased by $15,688.49. That is money owed by the customers that is unpaid. Think of like lending your customers money to pay for the goods or services they purchased. It is cash being taken out of the business.
On the other side of the balance sheet under the liabilities section, we see that the notes payable section increased by $25,000 during the year due to a long-term loan taken to finance the truck and some other needs in the business. The lender is giving cash to the business, resulting in an increase in cash for the business.
Lastly, in the equity section, we note that the business has net income, so far, of $997.75 which increases the business’ cash.
Now, the cash flow statement summarizes all of those balance sheet accounts on one report and groups them into sections; cash from operations, cash from investing and cash from financing. This enables management to see where the increase/decrease in cash came from very easily.
Here is the resulting cash flow statement.
The top section shows the net cash from operations. This was a “decrease” of cash totaling $7,687.53.
The second section show cash from investments. This also was a decrease from the $13,495 used to buy the truck.
The third section shows cash from financing, or an increase of $25,000 to cash.
If you total all three of these sections up, you get $3,817.47 which exactly matches the increase in the cash accounts.
So, when looking at this statement is the increase in cash a good thing?
The increase came from a long-term loan. As long as the business is sufficiently profitable that it can pay its expenses and payoff the loan and the loan helps it do that, than yes the loan was a good thing.
The money that is tied up in accounts receivables could be a concern, especially if these balances are becoming old and possibly noncollectable. This would be a great discussion point between management and the accountant/CFO.
So, there are the three reports I recommend all business owners review each month. Ideally, have key management and the head of accounting sit and discuss the material items. This could be just two people.
If you’re in need of a professional bookkeeper to prepare these statements for you and discuss them with you, I do have two openings right now and would love to discuss over the phone with you. Click HERE to connect to my contact page to set up a date and time with me.