Does this sound familiar? You receive your financial statements, take a glance and file them away? As long as the bills are paid, you don’t have the time to analyze a bunch of numbers. Let’s face it; the financial statements are packed with many numbers. We are all about the numbers at 4 Corners CFO, so today, we want to share some of the most important numbers on your financial statements. Now you can take that glance and focus on what you should pay close attention to every month. Spoiler alert – none of them are revenue.
Types of Profit on The Financial Statements
There are two key numbers to keep track of on your financial statements, specifically your profit and loss statement (otherwise known as an income statement) when it comes to profit.
Net income is the number that indicates if your business is profitable. It is the amount the company earns after deducting all your expenses and taxes. The net income, sometimes referred to as net profit, helps to determine the overall financial health of your business. Simply put, it shows that the business makes more than it spends. You want this number to be positive and preferably more than 10% of revenue…but we aren’t getting into ratios today.
Gross profit is a business’s profit after deducting costs related to manufacturing and selling products or services. It measures how efficiently a business uses labor, supplies, and person-hours to manufacture goods and deliver services to customers and clients. These costs are also referred to as cost of goods sold (COGS).
The gross profit helps you determine how much of your revenue can be used to run the rest of your business, including paychecks. When the COGS increases without a corresponding increase in revenue, the gross profit decreases. This means you have less money to deal with your operating expenses. When the COGS value decreases, gross profit will increase, which means you will have more funds to spend on your business operations.
You can calculate the gross profit by subtracting the cost of goods or services sold from your total sales. Bonus points if your bookkeeping is set up so you can easily do this by product or service category.
Cash flow is the cash balance that moves into and out of the business at a specific time. Cash is constantly moving through your company. When you hire a contractor and pay them, money flows out of your business. When you collect payments from clients, cash flows into the business.
Cash flow can be positive or negative. Positive cash flow means a company has more money moving in than moving out. Negative cash flow indicates a company has more money moving out of it than into it.
Types of Cash Flow
- Operating cash flow is the net cash from a company’s regular business operations.
- Investing cash flow is the net cash generated from a company’s investment-related activities.
- Financing cash flow is how cash moves between a company and its investors, owners, or creditors.
Don’t underestimate the impact of debt on your cash flow. The only way to pay the bills when cash flow is negative is to finance it. That financing comes at a cost, interest rates. Financing options will not always be available to your business, so a successful business has to learn to live within its available cash flow.
The easiest way to know how much cash is left in the business is by simply glancing at the balance in your bank account, balance sheet, or financial statements. Your bookkeeper can also provide a cash flow statement with the activities categorized. My favorite way to help clients keep an eye on their cash is through a cash flow forecast. It’s not technically a financial statement number but a key part of our clients’ financial package. I’ll talk more about cash flow forecasting in a different blog.
Equity is your ownership of the company. This is another number you will find on your balance sheet and often near the bottom. It is common, though not ideal, for a business to have negative equity in the first few years because they had to pay themselves and/or others from debt. Over time, a healthy business will move to pay all expenses, including payroll, from its current cash flow and begin paying down its debts. This will allow them to return to a positive equity position.
The business owner has the right to all the valuable items in the company and takes responsibility for the liabilities. The objects of value (also known as assets) include cash, property, inventory, trademarks, or patents. Assets can be tangible or intangible. A tangible asset is the physical things you can touch, like a building. Intangible assets are things you can’t touch, like copyrights.
Liabilities are the debts your business owes to another entity, organization, employee, vendor, or agency. If you have more liabilities than assets, your equity in the business will be negative because all of those valuable items are owed to others, not you.
Think of it like a car loan with no down payment. The day you buy the car, you have a $50,000 asset. However, you also have a $50,000 loan/liability. Because you financed the whole amount, you don’t actually “own” that car until you pay for it, and if you don’t make the payments, the bank can repossess and take it back.
The more you create assets (cash, property, inventory) without using liabilities to get there (debt, payables), the higher your equity and ownership in the company will be. Increasing your net income is a great way to generate more assets and, therefore more equity.
If you keep an eye on these three numbers, you will be able to understand and take the pulse of your company’s financial health. Get in touch if you want help to dive into your financial statements! We love working with our clients to better understand their businesses’ financial state!